Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 1 Multinational Financial Management: Opportunities and Challenges
1.1 The Global Financial Marketplace
1) Financial globalization has NOT resulted in:
A) continuing imbalances of balance of payments.
B) an increase in quantity and speed in the flow of capital across the world.
C) capital markets less open and a decrease in the availability of capital for many organizations.
D) uniform ways of ownership, control, and governance across the world.
Answer: D
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
2) Financial globalization has NOT resulted in:
A) continuing imbalances of balance of payments.
B) an increase in quantity and speed in the flow of capital across the world.
C) capital markets more open and an increase in the availability of capital for many
organizations.
D) an increase in the flow of capital into and out of industrialized markets.
Answer: C
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
3) The institutions of global finance are:
A) central banks.
B) commercial banks.
C) investment banks.
D) All of the above are institutions of global finance.
Answer: D
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
4) A well-established, large U.S.-based MNE will probably NOT be able to overcome which of
the following obstacles to maximizing firm value?
A) an open marketplace
B) high-quality strategic management
C) access to capital
D) none of the above
Answer: D
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Conceptual
AACSB: Application of knowledge
5) A well-established, large, China-based MNE will probably be most adversely affected by
which of the following elements of firm value?
A) an open marketplace
B) high-quality strategic management
C) access to capital
D) access to qualified labor pool
Answer: A
Diff: 2
L.O.: 1.1 The Global Financial Marketplace
Skill: Conceptual
AACSB: Application of knowledge
6) A well-established, large, Brazil-based MNE will probably be most adversely affected by
which of the following elements of firm value?
A) an open marketplace
B) high-quality strategic management
C) access to capital
D) access to qualified labor pool
Answer: C
Diff: 2
L.O.: 1.1 The Global Financial Marketplace
Skill: Conceptual
AACSB: Application of knowledge
7) A major cost avoided in the eurocurrency markets is the payment of deposit insurance fees,
such as:
A) Federal Deposit Insurance Corporation — FDIC.
B) Office of the Comptroller of the Currency OCC.
C) International Monetary Fund — IMF.
D) World Bank — WB.
Answer: A
Diff: 2
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
8) The modern eurocurrency market was born shortly after:
A) World War II.
B) World War I.
C) Korean War.
D) Bosnian War.
Answer: A
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
9) The reference rate of interest in the eurocurrency market is the:
A) London Interbank Offered Rate.
B) Prima rate.
C) Federal funds rate.
D) Treasury rate.
Answer: A
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
10) Interest spreads in the eurocurrency market are small for many reasons EXCEPT:
A) Eurocurrency loans are secured loans.
B) Eurocurrency deposits and loans are made in amounts of $500,000 or more on an unsecured
basis.
C) The eurocurrency is a wholesale market.
D) Borrowers are usually large corporations or government entities.
Answer: A
Diff: 2
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
11) Multinational enterprises (MNEs) are firms, both for-profit companies and not-for-profit
organizations, that have operations in more than one country, and conduct their business through
foreign subsidiaries, branches, or joint ventures with host country firms.
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
12) Ownership, control, and governance changes radically across the world. The publicly traded
company is not the dominant global business organization—the privately held or family-owned
business is the prevalent structure—and their goals and measures of performance differ
dramatically.
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
13) The securities at the heart of the global capital markets are the Mortgage Backed Securities
(MBS). The health and security of the global financial system rely on the quality of these
securities.
Answer: FALSE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
14) The U.S. dollar has been the focal point of currency trading since the 1940s. As a result,
most of the world's currencies are quoted against the dollar.
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
15) Several of the world's major currency exchange rates follow a specific quotation convention
that is the result of tradition and history. The exchange rate between the U.S. dollar and the euro
is always quoted as "dollars per euro."
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
16) Several of the world's major currency exchange rates follow a specific quotation convention
that is the result of tradition and history. The exchange rate between the U.S. dollar and the
British pound is always quoted as "dollars per pound."
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
17) Several of the world's major currency exchange rates follow a specific quotation convention
that is the result of tradition and history. The exchange rate between the U.S. dollar and the
Japanese yen is always quoted as "dollars per Japanese yen."
Answer: FALSE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
18) Your authors suggest that one way to characterize the global financial marketplace is through
its assets, institutions, and linkages.
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
19) Eurocurrencies are domestic currencies of one country on deposit in a second country.
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
20) A eurodollar deposit is a demand deposit.
Answer: FALSE
Diff: 2
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
21) Eurocurrency markets serve two valuable purposes: .1) Eurocurrency deposits are an
efficient and convenient money market device for holding excess corporate liquidity; and 2) the
Eurocurrency market is a major source of short-term bank loans to finance corporate working
capital needs, including the financing of imports and exports.
Answer: TRUE
Diff: 2
L.O.: 1.1 The Global Financial Marketplace
Skill: Conceptual
AACSB: Application of knowledge
22) The key factor attracting both depositors and borrowers to the Eurocurrency loan market is
the narrow interest rate spread within that market.
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Conceptual
AACSB: Application of knowledge
23) The Eurocurrency market continues to thrive because it is a large international money market
relatively free from governmental regulation and interference. Recent events may lead to greater
regulation.
Answer: TRUE
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Recognition
AACSB: Application of knowledge
24) The theme dominating global financial markets today is the complexity of risks associated
with financial globalization. List and explain examples of the complexity of risks affecting the
leading and managing of multinational firms in the rapidly moving marketplace.
Answer: The following is a sampling of this complexity of risks: 1) The international monetary
system is under constant scrutiny. The rise of the Chinese renminbi is changing much of the
world's outlook on currency exchange, reserve currencies, and the roles of the dollar and the
euro. 2) Large fiscal deficits, including the current eurozone crisis, plague most of the major
trading countries of the world, complicating fiscal and monetary policies, and ultimately, interest
rates and exchange rates. 3) Many countries experience continuing balance of payments
imbalances, and in some cases, dangerously large deficits and surpluses. 4) Ownership, control,
and governance vary radically across the world. 5) Global capital markets that normally provide
the means to lower a firm's cost of capital, and even more critically, increase the availability of
capital, have in many ways shrunk in size and have become less open and accessible to many of
the world's organizations. 6) Financial globalization has resulted in the ebb and flow of capital in
and out of both industrial and emerging markets, greatly complicating financial management.
Diff: 1
L.O.: 1.1 The Global Financial Marketplace
Skill: Conceptual
AACSB: Application of knowledge
25) Business involves the interaction of individuals and individual organizations for the
exchange of products, services, and capital through markets. The global capital markets are
critical for the conduct of this exchange. The authors suggest that one way to characterize the
global financial marketplace is through its assets, institutions, and linkages. Explain how each of
the three dimensions characterize the global financial marketplace.
Answer: 1) The financial assets at the heart of the global capital markets are the debt securities
issued by governments. These low-risk or risk-free assets (e.g., U.S. Treasury Bonds) form the
foundation for the creation, trading, and pricing of other financial assets like bank loans,
corporate bonds, and equities (stock). In recent years, a number of additional securities have
been created from existing securities-derivatives, whose value is based on market value changes
of the underlying securities. The health and security of the global financial system relies on the
quality of these assets. 2) The institutions of global finance are the central banks, which create
and control each country's money supply; the commercial banks, which take deposits and extend
loans to businesses, both local and global; and the multitude of other financial institutions
created to trade securities and derivatives. These institutions take many shapes and are subject to
many different regulatory frameworks. The health and security of the global financial system
relies on the stability of these financial institutions. 3) The links between the financial
institutions, the actual fluid or medium for exchange, are the interbank networks using currency.
The ready exchange of currencies in the global marketplace is the first and foremost necessary
element for the conduct of financial trading, and the global currency markets are the largest
markets in the world. The exchange of currencies, and the subsequent exchange of all other
securities globally via currency, is the international interbank network.
Diff: 2
L.O.: 1.1 The Global Financial Marketplace
Skill: Conceptual
AACSB: Application of knowledge
1.2 The Theory of Comparative Advantage
1) The theory that suggests specialization by country can increase worldwide production is:
A) the theory of comparative advantage.
B) the theory of foreign direct investment.
C) the international Fisher effect.
D) the theory of working capital management.
Answer: A
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT a reason governments interfere with comparative advantage?
A) Governments attempt to achieve full employment.
B) Governments promote economic development.
C) national self-sufficiency in defense-related industries
D) All are reasons governments interfere with comparative advantage.
Answer: D
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
3) Which of the following factors of production DO NOT flow freely between countries?
A) raw materials
B) financial capital
C) (non-military) technology
D) All of the above factors of production flow freely among countries.
Answer: A
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following would NOT be a way to implement comparative advantage?
A) IBM exports computers to Egypt.
B) Computer hardware is designed in the United States but manufactured and assembled in
Korea.
C) Water of the greatest purity is obtained from wells in Oregon, bottled, and exported
worldwide.
D) All of the above are examples of ways to implement comparative advantage.
Answer: D
Diff: 2
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Conceptual
AACSB: Application of knowledge
5) Of the following, which would NOT be considered a way that government interferes with
comparative advantage?
A) tariffs
B) managerial skills
C) quotas
D) other non-tariff restrictions
Answer: B
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
6) The concept of absolute comparative advantage's origins lie in:
A) Adam Smith's work of 1776.
B) David Ricardo's work of 1776.
C) The Wealth of Nations book, published in 1887.
D) On the Principles of Political Economy and Taxation book, published in 1817.
Answer: A
Diff: 3
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
7) The concept of relative comparative advantage's origins lie in:
A) Adam Smith's work of 1776.
B) David Ricardo's work of 1776.
C) The Wealth of Nations book, published in 1887.
D) On the Principles of Political Economy and Taxation book, published in 1817.
Answer: D
Diff: 3
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
8) Comparative advantage is one of the underlying principles driving the growth of global
business.
Answer: TRUE
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
9) The theory of comparative advantage owes it origins to Ben Bernanke as described in his book
The Wealth of Bankers.
Answer: FALSE
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
10) International trade might have approached the comparative advantage model in the 19th
century, and it does so even more today.
Answer: FALSE
Diff: 2
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
11) Comparative advantage shifts over time as less developed countries become more developed
and realize their latent opportunities.
Answer: TRUE
Diff: 2
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
12) Comparative advantage in the 21st century is based more on services and their cross border
facilitation by telecommunications and the Internet.
Answer: TRUE
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
13) Comparative advantage was once the cornerstone of international trade theory, but today it is
archaic, simplistic, and irrelevant for explaining investment choices made by MNEs.
Answer: FALSE
Diff: 2
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
14) When discussing comparative advantage, it is apparent that today at least two of the factors
of production, capital and technology, now flow directly and easily between countries, rather
than only indirectly through traded goods and services.
Answer: TRUE
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
15) It would be safe to make the statement that modern telecommunications now take business
activities to labor rather than moving labor to the places of business.
Answer: TRUE
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Conceptual
AACSB: Application of knowledge
16) As the general principle of comparative advantage is still valid, complete specialization
remains a realistic case.
Answer: FALSE
Diff: 2
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Recognition
AACSB: Application of knowledge
17) Although international trade might have approached the comparative advantage model
during the nineteenth century, it certainly does not today, for a variety of reasons. Develop an
argument as to why this is not happening today.
Answer: Countries do not appear to specialize only in those products that could be most
efficiently produced by that country's particular factors of production. Instead, governments
interfere with comparative advantage for a variety of economic and political reasons, such as to
achieve full employment, economic development, national self-sufficiency in defense-related
industries, and protection of an agricultural sector's way of life. Government interference takes
the form of tariffs, quotas, and other non-tariff restrictions. The classical model of comparative
advantage also did not really address certain other issues such as the effect of uncertainty and
information costs, the role of differentiated products in imperfectly competitive markets, and
economies of scale.
Diff: 1
L.O.: 1.2 The Theory of Comparative Advantage
Skill: Conceptual
AACSB: Application of knowledge
1.3 What Is Different About International Financial Management?
1) Which of the following domestic financial instruments have NOT been modified for use in
international financial management?
A) currency options and futures
B) interest rate and currency swaps
C) letters of credit
D) All of the above are domestic financial instruments that have also been modified for use in
international financial markets.
Answer: D
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT always understood by MNE management?
A) culture, history, and institutions
B) political risk
C) foreign exchange risk
D) financial instruments
Answer: A
Diff: 2
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
3) In determining why a firm becomes multinational there are many reasons. One reason is that
the firm is a market seeker. Which of the following is NOT a reason why market-seeking firms
produce in foreign countries?
A) satisfaction of local demand in the foreign country
B) to export to foreign markets
C) political safety and small likelihood of government expropriation of assets
D) All of the above are market-seeking activities.
Answer: C
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
4) ________ investments are designed to promote and enhance the growth and profitability of
the firm. ________ investments are designed to deny those same opportunities to the firm's
competitors.
A) Conservative; Aggressive
B) Defensive; Proactive
C) Proactive; Defensive
D) Aggressive; Proactive
Answer: C
Diff: 2
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
5) In determining why a firm becomes multinational there are many reasons. One reason is that
the firm is a raw material seeker. Which of the following is NOT a reason why raw material
seeker extract raw materials in foreign countries?
A) They extract raw materials wherever they can be found to export from the host country.
B) They extract raw materials wherever they can be found for sale in the host country.
C) They extract raw materials wherever they can be found for further processing in the host
country.
D) All of the above.
Answer: D
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
6) MNEs must modify finance theories like cost of capital and capital budgeting because of
foreign complexities.
Answer: TRUE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
7) Relative to MNEs, purely domestic firms tend to have GREATER political risk.
Answer: FALSE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
8) Domestic firms tend to make GREATER use of financial derivatives than MNEs because they
can bear the greater risk presented by these financial instruments.
Answer: FALSE
Diff: 2
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
9) Because countries have different financial regulations and customs, it is common for MNEs to
apply their domestic rules and regulations when doing financial business in a foreign country.
Answer: FALSE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Conceptual
AACSB: Application of knowledge
10) A number of financial instruments that are used in domestic financial management have been
modified for use in international financial management. Examples are foreign currency options
and futures, interest rate and currency swaps, and letters of credit.
Answer: TRUE
Diff: 2
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
11) Domestic firms do not have foreign exchange risk.
Answer: FALSE
Diff: 2
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
12) Large international firms are better able to exploit product differentiation than are their local
competitors.
Answer: TRUE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
13) For firms competing in a world characterized by oligopolistic competition, strategic motives
can be subdivided into proactive and defensive investments.
Answer: TRUE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
14) Defensive measures are designed to enhance growth and profitability of the firm itself.
Answer: FALSE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
15) In determining why a firm becomes multinational there are many reasons. One reason is that
the firm is a knowledge seeker. They operate in foreign countries to exploit existing
technological expertise.
Answer: FALSE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
16) The five strategic motives driving the decision to invest abroad and become an MNE (market
seekers, raw material seekers, production efficiency seekers, knowledge seekers, and political
safety seekers) are mutually exclusive.
Answer: FALSE
Diff: 1
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Recognition
AACSB: Application of knowledge
17) In the recent past, much of the business development in multinational firms was led by cross-
functional teams, teams of professionals who are competent over a broader array of functional
fields. Develop an argument as to why this is the case.
Answer: Teams are increasingly virtual and unique, each team custom-tailored for the business
proposal or opportunity, and often drawing upon the available talent across geographies,
markets, and cultures. Organizational agility, a phrase often used to describe decision-making
rather than the decision-makers, requires different skills. This require business professionals who
are fundamentally competent over a broader array of functional fields — and that would include
more than a passing of knowledge of multinational finance and how impacts investments and
operations. Knowledge of the financial dimensions of the business in the international business
environment is more and more a concern for all.
Diff: 2
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Conceptual
AACSB: Application of knowledge
18) List and explain three strategic motives why firms become multinationals and give an
example of each.
Answer: The authors provide 5 strategic motives for firms to become multinationals: market
seekers, raw materials seekers, production efficiency seekers, knowledge seekers, and political
safety seekers. Market seekers are looking for more consumers for their products such as
automobiles or steel. Knowledge seekers may be looking for an educated work force similar to
the way firms seeking R and D set up shop in university towns. Raw materials seekers may be
after commodities such as oil or copper. Production efficiencies may occur in countries like
Mexico that have capable workers and lower wages. Political safety seekers are looking for
countries that will not expropriate their assets, so they may stay away from countries that in the
post have engaged in such activities.
Diff: 2
L.O.: 1.3 What Is Different about International Financial Management?
Skill: Conceptual
AACSB: Application of knowledge
1.4 The Globalization Process
1) The phase of the globalization process characterized by imports from foreign suppliers and
exports to foreign buyers is called the:
A) domestic phase.
B) multinational phase.
C) international trade phase.
D) import-export banking phase.
Answer: C
Diff: 1
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
2) The authors describe the multinational phase of globalization for a firm as one characterized
by the:
A) ownership of assets and enterprises in foreign countries.
B) potential for international competitors or suppliers even though all accounts are with domestic
firms and are denominated in dollars.
C) imports from foreign suppliers and exports to foreign buyers.
D) requirement that all employees be multilingual.
Answer: A
Diff: 1
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
3) A firm in the International Trade Phase of Globalization:
A) makes all foreign payments in foreign currency units and all foreign receipts in domestic
currency units.
B) receives all foreign receipts in foreign currency units and makes all foreign payments in
domestic currency units.
C) bears direct foreign exchange risk.
D) none of the above
Answer: C
Diff: 1
L.O.: 1.4 The Globalization Process
Skill: Conceptual
AACSB: Application of knowledge
4) Of the following, which was NOT mentioned by the authors as an increase in the demands of
financial management services due to increased globalization by the firm?
A) evaluation of the credit quality of foreign buyers and sellers
B) foreign consumer method of payment preferences
C) credit risk management
D) evaluation of foreign exchange risk
Answer: B
Diff: 2
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
5) The twin agency problems limiting financial globalization are caused by these two groups
acting in their own self-interests rather than the interests of the firm.
A) rulers of sovereign states and unsavory customs officials
B) corporate insiders and attorneys
C) corporate insiders and rulers of sovereign states
D) attorneys and unsavory customs officials
Answer: C
Diff: 2
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
6) Typically, a firm in its domestic stage of globalization has all financial transactions in its
domestic currency.
Answer: TRUE
Diff: 1
L.O.: 1.4 The Globalization Process
Skill: Conceptual
AACSB: Application of knowledge
7) Typically, a "greenfield" investment abroad is considered an investment having a greater
foreign presence than a joint venture with a foreign firm.
Answer: TRUE
Diff: 1
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
8) The authors argue that financial inefficiency caused by influential insiders may prove to be an
increasingly troublesome barrier to international finance.
Answer: TRUE
Diff: 2
L.O.: 1.4 The Globalization Process
Skill: Conceptual
AACSB: Application of knowledge
9) The authors describe a process for development of a MNE that begins with a purely domestic
phase, followed by the multinational phase, and topping out with the international trade phase.
Answer: FALSE
Diff: 2
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
10) Today it is widely assumed that there are NO LIMITS to financial globalization.
Answer: FALSE
Diff: 2
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
11) The growth in the influence and self-enrichment of organizational insiders is seen as an
impediment to the growth of financial globalization in general.
Answer: TRUE
Diff: 2
L.O.: 1.4 The Globalization Process
Skill: Recognition
AACSB: Application of knowledge
12) Describe the structural and managerial changes and challenges experienced by a firm as it
moves its operations from domestic to global (globalization process).
Answer: A firm's initial strategy is to develop a sustainable competitive advantage in the U.S.
market (domestic phase). As firms becomes visible and viable competitors in the U.S. market,
strategic opportunities arise to expand the firm's market reach by exporting product and services
to one or more foreign markets and/or by importing inputs (international trade phase). If
companies are successful in their international trade activities, the time will come when the
globalization process will progress to the next phase. Companies will soon need to establish
foreign sales and service affiliates. This step is often followed by establishing manufacturing
operations abroad or by licensing foreign firms to produce and service (multinational phase).
Once companies own assets and enterprises in foreign countries, they have entered the
multinational phase of their globalization.
Diff: 3
L.O.: 1.4 The Globalization Process
Skill: Conceptual
AACSB: Application of knowledge
13) The objectives and responsibilities of the modern multinational have grown significantly
more complex in the twenty-first century. Develop and argument as to why this is the case.
Answer: It is accepted that the purpose of the corporation is to certainly create profits and value
for its stakeholders, but the responsibility of the corporation is to do so in a way that inflicts no
costs on society, including the environment. This developing controversy has been somewhat
hampered to date by conflicting terms and labels—corporate goodness, corporate responsibility,
corporate social responsibility (CSR), corporate philanthropy, and corporate sustainability, to list
but a few. Confusion can be reduced by using a guiding principle—that sustainability is a goal,
while responsibility is an obligation. It follows that the obligation of leadership in the modern
multinational is to pursue profit, social development, and the environment, all along sustainable
principles.
Diff: 2
L.O.: 1.4 The Globalization Process
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 2 The International Monetary System
2.1 History of the International Monetary System
1) Under the gold standard of currency exchange that existed from 1879 to 1914, an ounce of
gold cost $20.67 in U.S. dollars and £4.2474 in British pounds. Therefore, the exchange rate of
pounds per dollar under this fixed exchange regime was:
A) £4.8665/$.
B) £0.2055/$.
C) always changing because the price of gold was always changing.
D) unknown because there is not enough information to answer this question.
Answer: B
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Analytical
AACSB: Analytical thinking
2) World War I caused the suspension of the gold standard for fixed international exchange rates
because the war:
A) cost too much money.
B) interrupted the free movement of gold.
C) lasted too long.
D) used gold as the main ingredient in armament plating.
Answer: B
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
3) The post WWII international monetary agreement that was developed in 1944 is known as
the:
A) United Nations.
B) League of Nations.
C) Yalta Agreement.
D) Bretton Woods Agreement.
Answer: D
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
4) Another name for the International Bank for Reconstruction and Development is:
A) the Recon Bank.
B) the European Monetary System.
C) the Marshall Plan.
D) the World Bank.
Answer: D
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
5) The International Monetary Fund (IMF):
A) in recent years has provided large loans to Russia, South Korea, and Brazil.
B) was created as a result of the Bretton Woods Agreement.
C) aids countries with balance of payment and exchange rate problems.
D) is all of the above.
Answer: D
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
6) One of the innovations introduced by Bretton Woods was the creation of the Special Drawing
Right or SDR. The SDR is an international reserve asset created by the:
A) U.S. Department of the Treasury.
B) International Bank of Reconstruction and Development (IBRD).
C) World Bank (WB).
D) International Monetary Fund (IMF).
Answer: D
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
7) Which of the following led to the eventual demise of the fixed currency exchange rate regime
worked out at Bretton Woods?
A) widely divergent national monetary and fiscal policies among member nations
B) differential rates of inflation across member nations
C) several unexpected economic shocks to member nations
D) all of the above
Answer: D
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
8) Which of the following statements is NOT true?
A) The Gold Standard Era was characterized by growing openness in trade, but limited capital
mobility.
B) The time period between World Wars I and II (the inter war years) witnessed significant
reductions in trade barriers and a rapid acceleration in international trade.
C) The Bretton Woods Era (post WWII) realized the increasing benefits of open economies.
Furthermore, trade was increasingly dominated by capital.
D) Since March 1973, exchange rates have become much more volatile and less predictable than
previous periods.
Answer: B
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
9) A review of the evolution of the Global Monetary System shows that capital flows dominate
trade in which of the following eras EXCEPT:
A) Classical Gold Standard.
B) Fixed Exchange Rates, 1945-1973.
C) The Floating Era, 1973-1997.
D) The Emerging Era, 1997-Present.
Answer: A
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
10) Since 2009 the IMF's exchange rate regime classification system uses a "de facto
classification" methodology. Under this system, a country that has given up their own
sovereignty over monetary policy is considered to have:
A) a residual agreement.
B) hard pegs.
C) soft pegs.
D) floating arrangements.
Answer: B
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
11) Since 2009 the IMF's exchange rate regime classification system uses a "de facto
classification" methodology. Under this system, countries with "fixed exchange rates" are
considered to have:
A) a residual agreement.
B) soft pegs.
C) hard pegs.
D) floating arrangements.
Answer: B
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
12) A small economy country whose GDP is heavily dependent on trade with the United States
could use a(n) ________ exchange rate regime to minimize the risk to their economy that could
arise due to unfavorable changes in the exchange rate.
A) pegged exchange rate with the United States
B) pegged exchange rate with the Euro
C) independent floating
D) managed float
Answer: A
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Conceptual
AACSB: Application of knowledge
13) Since 2009 the IMF's exchange rate regime classification system uses a "de facto
classification" methodology. Under this system, currencies that are predominantly market-driven
are considered to be:
A) soft pegs.
B) hard pegs.
C) floating arrangements.
D) a residual agreement.
Answer: C
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
14) Among IMF member countries since 2010, the dominating exchange rate regime has been:
A) hard peg.
B) soft peg.
C) floating arrangements.
D) residual agreement.
Answer: B
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
15) Under the terms of Bretton Woods, countries tried to maintain the value of their currencies to
within 1% of a hybrid security made up of the U.S. dollar, British pound, and Japanese yen.
Answer: FALSE
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
16) Members of the International Monetary Fund may settle transactions among themselves by
transferring Special Drawing Rights (SDRs).
Answer: TRUE
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
17) Today, the United States has been ejected from the International Monetary Fund for refusal
to pay annual dues.
Answer: FALSE
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
18) From the time of its creation through September 2017, the euro peaked versus the USD in
April 2008 at around $1.60/.
Answer: TRUE
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
19) Since March 1973, when exchange rates become more volatile and less predictable than
during the "fixed" exchange rate period, the nominal exchange rate index of the U.S. dollar
peaked in 2011.
Answer: FALSE
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
20) The euro is an example of a rigidly fixed system, acting as a single currency for its member
countries. However, the euro itself is an independently floating currency against all other
currencies.
Answer: TRUE
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
21) Although the contemporary international monetary system is typically referred to as a
"floating regime," it is clearly not the case for the majority of the world's nations.
Answer: TRUE
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
22) The IMF's methodology for classifying exchange rate regimes today is based on the official
policy statement of the respective governments, de jure classification.
Answer: FALSE
Diff: 1
L.O.: 2.1 History of the International Monetary System
Skill: Recognition
AACSB: Application of knowledge
23) Most Western nations were on the gold standard for currency exchange rates from 1876 until
1914. Today we have several different exchange rate regimes in use, but most larger economy
nations have freely floating exchange rates today and are not obligated to convert their currency
into a predetermined amount of gold on demand. Currently several parties still call for the "good
old days" and a return to the gold standard. Develop an argument as to why this is a good idea.
Answer: The gold standard forces a nation to maintain sufficient reserves of gold to back its
currency's value. This helps control inflation, as a country cannot print additional money without
sufficient gold to back it up. The gold standard eases international transactions as there is little
uncertainly about exchange rates for trade with foreign countries.
Diff: 3
L.O.: 2.1 History of the International Monetary System
Skill: Conceptual
AACSB: Application of knowledge
24) The mobility of international capital flows is causing emerging market nations to choose
between a free-floating currency exchange regime and a currency board (or taken to the limit,
dollarization). Describe how each of the regimes would work and identify at least two likely
economic results for each regime.
Answer: With free float the exchange rate is market determined and beyond the control of the
country's central bank or government. The economic results are likely to be an independent
monetary policy, free movement of capital, but less stability in the exchange rate. Such
instability may be more than an emerging market country's small financial market can bear. A
currency board on the other hand is an implied legislative commitment to fix the foreign
exchange rate with a specific currency, generally the country's major trading partner.
Dollarization is taking this policy to the extreme whereby the emerging market nation forgoes its
currency for that of its major trading partner. An example of Dollarization is Panama using U.S.
dollars as the official Panamanian currency. With such a regime, independent monetary policy is
lost and political influence on monetary policy is eliminated. However, the benefits accruing to
countries as a result of the ability to print its own money, seigniorage, is lost.
Diff: 2
L.O.: 2.1 History of the International Monetary System
Skill: Conceptual
AACSB: Application of knowledge
2.2 Fixed Versus Flexible Exchange Rates
1) Based on the premise that, other things equal, countries would prefer a fixed exchange rate,
which of the following statements is NOT true?
A) Fixed rates provide stability in international prices for the conduct of trade.
B) Fixed exchange rate regimes necessitate that central banks maintain large quantities of
international reserves for use in the occasional defense of the fixed rate.
C) Fixed rates are inherently inflationary in that they require the country to follow loose
monetary and fiscal policies.
D) Stable prices aid in the growth of international trade and lessen exchange rate risks for
businesses.
Answer: C
Diff: 2
L.O.: 2.2 Fixed Versus Flexible Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
2) According to the terminology associated with changes in currency values, which of the
following choices is the case when a currency's value relative to other currencies is changed by a
government?
A) depreciation and revaluation
B) devaluation and appreciation
C) devaluation and revaluation
D) depreciation and appreciation
Answer: C
Diff: 2
L.O.: 2.2 Fixed Versus Flexible Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
3) Based on the premise that, other things equal, countries would prefer a fixed exchange rate:
Variable rates provide stability in international prices for the conduct of trade.
Answer: FALSE
Diff: 1
L.O.: 2.2 Fixed Versus Flexible Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
4) If exchange rates were fixed, investors and traders would be relatively certain about the
current and near future exchange value of each currency.
Answer: TRUE
Diff: 1
L.O.: 2.2 Fixed Versus Flexible Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
5) According to the terminology associated with changes in currency values, depreciation is a
case when a currency's value relative to other currencies is changed by a government.
Answer: FALSE
Diff: 1
L.O.: 2.2 Fixed Versus Flexible Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
6) By and large, high capital mobility is forcing emerging market nations to choose between the
two extremes of a free-floating exchange rate or a hard peg regime.
Answer: TRUE
Diff: 1
L.O.: 2.2 Fixed Versus Flexible Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
2.3 The Impossible Trinity
1) Which of the following is NOT an attribute of the "ideal" currency?
A) monetary independence
B) full financial integration
C) exchange rate stability
D) All are attributes of an ideal currency.
Answer: D
Diff: 1
L.O.: 2.3 The Impossible Trinity
Skill: Conceptual
AACSB: Application of knowledge
2) The authors discuss the concept of the "Impossible Trinity" or the inability to achieve
simultaneously the goals of exchange rate stability, full financial integration, and monetary
independence. If a country chooses to have a pure float exchange rate regime, which two of the
three goals is a country most able to achieve?
A) monetary independence and exchange rate stability
B) exchange rate stability and full financial integration
C) full financial integration and monetary independence
D) A country cannot attain any of the exchange rate goals with a pure float exchange rate regime.
Answer: C
Diff: 2
L.O.: 2.3 The Impossible Trinity
Skill: Conceptual
AACSB: Application of knowledge
3) China today is a clear example of a nation that has chosen the following policies EXCEPT:
A) control and manage the value of its currency.
B) conduct an independent monetary policy.
C) full financial integration in an attempt to stimulate its domestic economy.
D) restrict the flow of capital into and out of the country.
Answer: C
Diff: 2
L.O.: 2.3 The Impossible Trinity
Skill: Conceptual
AACSB: Application of knowledge
4) List and explain the three attributes (often referred as the impossible trinity) an ideal currency
would possess if existed in today's world.
Answer: If the ideal currency existed in today's world, it would possess the following three
attributes, often referred to as the impossible trinity: 1) Exchange rate stability: the value of the
currency is fixed (and relatively certain) in relationship to other major currencies. 2) Full
financial integration: complete freedom of monetary flows would be allowed. 3) Monetary
independence: domestic monetary and interest rate policies would be set by each individual
country to pursue desired national economic policies. These qualities are termed the impossible
trinity because the forces of economics do not allow a country to simultaneously achieve all
three goals.
Diff: 1
L.O.: 2.3 The Impossible Trinity
Skill: Conceptual
AACSB: Application of knowledge
2.4 A Single Currency for Europe: The Euro
1) Which of the following is NOT a required convergence criterion to become a full member of
the European Economic and Monetary Union (EMU)?
A) National birthrates must be at 2.0 or lower per person.
B) The fiscal deficit should be no more than 3% of GDP.
C) Nominal inflation should be no more than 1.5% above the average inflation rate for the three
members with the lowest inflation rates in the previous year.
D) Government debt should be no more than 60% of GDP.
Answer: A
Diff: 2
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Recognition
AACSB: Application of knowledge
2) According to the authors, what is the single most important mandate of the European Central
Bank?
A) Promote international trade for countries within the European Union.
B) Price, in euros, all products for sale in the European Union.
C) Promote price stability within the European Union.
D) Establish an EMU trade surplus with the United States.
Answer: C
Diff: 2
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Conceptual
AACSB: Application of knowledge
3) Which of the following is a way in which the euro affects markets?
A) Countries within the Euro zone enjoy cheaper transaction costs.
B) Currency risks and costs related to exchange rate uncertainty are reduced.
C) Consumers and business enjoy price transparency and increased price-based competition.
D) all of the above
Answer: D
Diff: 1
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Conceptual
AACSB: Application of knowledge
4) For the three years from early 2002 to early 2005, the euro maintained a strong and steady rise
in value against the U.S. dollar (USD). After a brief respite in 2005, the euro continued its climb
against the USD into 2008. Which of the following were NOT a contributing factor in the assent
of the euro and the decline in the dollar?
A) severe U.S. balance of payments deficits
B) a general weakening of the dollar after the attacks of September 11, 2001
C) large U.S. balance of payment surpluses
D) All of the above were contributing factors.
Answer: C
Diff: 1
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Conceptual
AACSB: Application of knowledge
5) The countries that use the euro as their currency have:
A) agreed to use a single currency (exchange rate stability), allow the free movement of capital
in and out of their economies (financial integration), but give up individual control of their own
money supply (monetary independence).
B) gained control over their own money supply (monetary independence), allowed the free
movement of capital in and out of their economies (financial integration), but give up exchange
rate stability.
C) agreed to use a single currency (exchange rate stability), allow individual control of their own
money supply (monetary independence), but give up the free movement of capital in and out of
their economies (financial integration).
D) none of the above
Answer: A
Diff: 2
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Recognition
AACSB: Application of knowledge
6) The Euro currency is fixed against other currencies on the international currency exchange
markets, but allows member country currencies to float against each other.
Answer: FALSE
Diff: 1
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Recognition
AACSB: Application of knowledge
7) The European Central Bank is a strong and independent central bank that has completely
replaced the individual central banks of the countries that use the euro as their currency.
Answer: FALSE
Diff: 2
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Recognition
AACSB: Application of knowledge
8) The members of the EU do have relative freedom to set their own fiscal policies—government
spending, taxation, and the creation of government surpluses or deficits. They are expected to
keep deficit spending within limits.
Answer: TRUE
Diff: 2
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Recognition
AACSB: Application of knowledge
9) List and explain three benefits the euro would generate for the states participating in the
European Economic and Monetary Union.
Answer: The euro would generate a number of benefits for the participating states: 1) Countries
within the eurozone enjoy cheaper transaction costs; 2) Currency risks and costs related to
exchange rate uncertainty are reduced; and 3) All consumers and businesses both inside and
outside the eurozone enjoy price transparency and increased price-based competition. The
primary "cost" of adopting the euro, the loss of monetary independence.
Diff: 1
L.O.: 2.4 A Single Currency for Europe: The Euro
Skill: Conceptual
AACSB: Application of knowledge
2.5 Emerging Markets and Regime Choices
1) Beginning in 1991, Argentina conducted its monetary policy through a currency board. In
January 2002, Argentina abandoned the currency board and allowed its currency to float against
other currencies. The country took this step because:
A) the Argentine Peso had grown too strong against major trading powers thus the currency
board policies were hurting the domestic economy.
B) the United States required the action as a prerequisite to finalizing a free trade zone with all of
North, South, and Central America.
C) the Argentine government lost the ability to maintain the pegged relationship as in fact
investors and traders perceived a lack of equality between the Argentine Peso and the U.S.
dollar.
D) all of the above
Answer: C
Diff: 2
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
2) In January 2002, the Argentine Peso changed in value from Peso1.00/$ to Peso1.40/$; thus,
the Argentine Peso ________ against the U.S. dollar.
A) strengthened
B) weakened
C) remained neutral
D) all of the above
Answer: B
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Analytical
AACSB: Analytical thinking
3) In January 2000 Ecuador officially replaced its national currency, the Ecuadorian sucre, with
the U.S. dollar. This practice is known as:
A) bi-currencyism.
B) securitization
C) a Yankee bailout.
D) dollarization.
Answer: D
Diff: 2
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Conceptual
AACSB: Application of knowledge
4) You have been hired as a consultant to the central bank for a country that has for many years
suffered from repeated currency crises and depends heavily on the U.S. financial and product
markets. Which of the following policies would have the greatest effectiveness for reducing
currency volatility of the client country with the United States?
A) dollarization
B) an exchange rate pegged to the U.S. dollar
C) an exchange rate with a fixed price per ounce of gold
D) an internationally floating exchange rate
Answer: A
Diff: 2
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Conceptual
AACSB: Application of knowledge
5) Which of the following is NOT an argument against dollarization?
A) Dollarization causes a loss of sovereignty over domestic monetary policy.
B) Dollarization removes currency volatility against the dollar.
C) Dollarization causes the country to lose the power of seigniorage.
D) The central bank of the dollarized country loses the role of lender of last resort.
Answer: B
Diff: 2
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
6) The ability of a country to profit from its ability to print money is known as:
A) profiteering.
B) dollarization.
C) seigniorage.
D) inflation.
Answer: C
Diff: 2
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
7) Which of the following factors make it difficult for emerging market economies to choose a
specific currency regime?
A) weak fiscal, financial, and monetary institutions
B) the tendency for commerce to allow currency substitution and the denomination of liabilities
in dollars
C) the emerging market's vulnerability to sudden stoppages of outside capital flows
D) all of the above
Answer: D
Diff: 2
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Conceptual
AACSB: Application of knowledge
8) Of the following, which is NOT a trade-off that must be dealt with in any exchange rate
regime?
A) cooperation vs. independence
B) rules vs. discretionary action
C) dollars vs. pounds
D) All of the above are rate regime trade-offs.
Answer: C
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
9) The following are examples of degrees of internationalization of an international currency
EXCEPT:
A) First degree of internationalization is when an international currency becomes readily
accessible for trade.
B) A second degree of internationalization is when an international currency is used for
international investment.
C) A third degree of internationalization is when an international currency is used for
international investment.
D) A third degree of internationalization is when an international currency takes the role of a
reserve currency.
Answer: C
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
10) A currency board exists when a country's central bank commits to back its money supply
entirely with foreign reserves at all times.
Answer: TRUE
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
11) A currency board exists when a country's central bank commits to back a fraction of its
money base with foreign reserves at all times.
Answer: FALSE
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
12) Dollarization is a common solution for countries suffering from currency revaluation.
Answer: FALSE
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
13) All exchange rate regimes must deal with the trade-off between rules and discretion as well
as between cooperation and independence.
Answer: TRUE
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
14) Regime structures like the gold standard required no cooperative policies among countries,
only the assurance that all would abide by the "rules of the game."
Answer: TRUE
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Recognition
AACSB: Application of knowledge
15) Bretton Woods required less in the way of cooperation among countries than did the gold
standard.
Answer: FALSE
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Conceptual
AACSB: Application of knowledge
16) The People's Republic of China has two official currencies, the Chinese renminbi (RMB) and
the yuan (CNY).
Answer: FALSE
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Conceptual
AACSB: Application of knowledge
17) Dollarization is the use of the U.S. dollar as the official currency of the country. List and
explain the arguments for and against dollarization. Provide example/s of countries that used the
dollar as its official currency.
Answer: The arguments for dollarization are: 1) country that dollarizes removes any currency
volatility (against the dollar) and would theoretically eliminate the possibility of future currency
crises, 2) expectations of greater economic integration with other dollar-based markets, both
product and financial. This last point has led many to argue in favor of regional dollarization.
Three major arguments exist against dollarization. The first is the loss of sovereignty over
monetary policy. This is, however, the point of dollarization. Second, the country loses the
power of seigniorage, the ability to profit from its ability to print its own money. Third, the
central bank of the country, because it no longer has the ability to create money within its
economic and financial system, can no longer serve the role of lender of last resort. This role
carries with it the ability to provide liquidity to save financial institutions that may be on the
brink of failure during times of financial crisis.
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Conceptual
AACSB: Application of knowledge
18) Explain how all exchange rate regimes must deal with the trade-off between rules and
discretion, as well as between cooperation and independence. List and classified two
International Monetary Systems based on these four quadrants.
Answer: 1) Vertically, different exchange rate arrangements may dictate whether a country's
government has strict intervention requirements (rules) or if it may choose whether, when, and to
what degree to intervene in the foreign exchange markets (discretion). 2) Horizontally, the trade-
off for countries participating in a specific system is between consulting and acting in unison
with other countries (cooperation) or operating as a member of the system, but acting on their
own (independence).
Regime structures like the gold standard required no cooperative policies among countries, only
the assurance that all would abide by the "rules of the game." Under the gold standard, this
assurance translated into the willingness of governments to buy or sell gold at parity rates on
demand. The Bretton Woods Agreement, the system in place between 1944 and 1973, required
more in the way of cooperation, in that gold was no longer the "rule," and countries were
required to cooperate to a higher degree to maintain the dollar-based system. Exchange rate
systems, like the European Monetary System's (EMS) fixed exchange rate band system used
from 1979 to 1999, were hybrids of these cooperative and rule regimes.
Diff: 1
L.O.: 2.5 Emerging Markets and Regime Changes
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 3 The Balance of Payments
3.1 Fundamentals of BOP Accounting
1) Which of the following is NOT a major subaccount of the Balance of Payments?
A) the financial account
B) the accounts payable
C) the capital account
D) the current account
Answer: B
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following international transactions would NOT be counted as a balance of
payments (BOP) transaction?
A) An American tourist purchases cheese in Milwaukee, Wisconsin.
B) The U.S. subsidiary of a British firm pays profits (dividends) back to its parent firm in
London.
C) A Canadian lumber baron purchases a U.S. corporate bond through an investment broker in
Seattle.
D) All of the above are considered BOP transactions.
Answer: A
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
3) The balance of payments as applied to a course in international finance may be defined as:
A) the amount still owed by an exporting firm after making an initial down payment.
B) the amount still owed by governments to the International Monetary Fund.
C) the measurement of all international economic transactions between the residents of a country
and foreign residents.
D) the amount of a country's merchandise trade deficit or surplus.
Answer: C
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Conceptual
AACSB: Application of knowledge
4) Balance of payment (BOP) data may be important for any of the following reasons:
A) BOP data helps to forecast a country's market potential, especially in the short run.
B) The BOP is an important indicator of a country's foreign exchange rate.
C) Changes in a country's BOP may signal a change in controls over payment of dividends and
interest.
D) all of the choices provided above
Answer: D
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Conceptual
AACSB: Application of knowledge
5) A country experiencing a serious BOT ________ is more likely to ________ exports than
otherwise.
A) surplus; contract
B) surplus; expand
C) deficit; expand
D) none of the above
Answer: A
Diff: 2
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Analytical
AACSB: Analytical thinking
6) Which of the following would NOT be considered a typical BOP transaction?
A) Toyota U.S.A. is a U.S. distributor of automobiles manufactured in Japan by its parent
company.
B) The U.S. subsidiary of European financial giant, Credit Suisse, pays dividends to its parent in
Zurich.
C) A U.S. tourist purchases gifts at a museum in London.
D) All are examples of BOP transactions.
Answer: D
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Conceptual
AACSB: Application of knowledge
7) Which of the following is NOT an item to be considered in BOP calculations?
A) A foreign resident purchases a U.S. Treasury Bill.
B) A U.S.-based firm manages the development of an oil field in Kazakhstan.
C) A consumer buys a VCR made in Korea from a Florida Wal-Mart store.
D) A U.S. citizen living in Minnesota travels to Winnipeg, Canada, and buys a case of LaBatt's
Canadian beer.
Answer: C
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Conceptual
AACSB: Application of knowledge
8) The balance of payments:
A) determines the eligibility of countries for IMF aid.
B) adds up the value of all assets and liabilities of a country on a specific date.
C) records all international transactions for a country over a period of time.
D) all of the above
Answer: C
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
9) An American tourist purchases a leather jacket while in Italy. Which of the following
statements is true?
A) The leather purchase would be considered an import for the U.S. BOP.
B) This transaction would be properly accounted for in the Current Account of the U.S. BOP.
C) The leather purchase is considered an import of a good, and thus, considered part of the
balance of trade as well.
D) All of these statements are true.
Answer: D
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
10) Which of the following statements about the balance of payments is NOT true?
A) The BOP is the summary statement of all international transactions between one country and
all other countries.
B) The BOP is a flow statement, summarizing all international transactions that occur across the
geographic borders over a period of time, typically a year.
C) Although the BOP must always balance in theory, in practice there are substantial imbalances
as a result of statistical errors and misreporting of current account and financial account flows.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
11) When the world went to a system of floating exchange rates, the Balance of Payments
became a relic of a system of fixed exchange rates and is no longer watched by serious economic
groups.
Answer: FALSE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Conceptual
AACSB: Application of knowledge
12) The BOP should always balance.
Answer: FALSE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
13) Changes in the BOP may predict the imposition or removal of foreign exchange controls.
Answer: TRUE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Conceptual
AACSB: Application of knowledge
14) A country experiencing a serious trade deficit is not as likely to expand imports as it would
be if running a surplus.
Answer: TRUE
Diff: 2
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Analytical
AACSB: Analytical thinking
15) The authors identify a tip for understanding BOP accounting. They recommend that you
"follow the cash flow."
Answer: TRUE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
16) The BOP must be in balance, but the current account need not be.
Answer: FALSE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
17) Expenditures by U.S. tourists in foreign countries for foreign goods or services are factored
into BOP calculations.
Answer: FALSE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
18) Like a balance sheet, the Balance of Payments adds up the value of all assets and liabilities
of a country on a specific date.
Answer: FALSE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
19) Because current and financial/capital account balances use double-entry bookkeeping it is
unusual to find serious discrepancies in the debits and credits.
Answer: FALSE
Diff: 1
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Recognition
AACSB: Application of knowledge
20) The measurement of all international economic transactions that take place between the
residents of a country and foreign residents is called the balance of payments (BOP). List and
explain three reasons why host-country BOP data is important to managers and investors.
Answer: BOP data is also important for the following reasons: 1) The BOP is an important
indicator of pressure on a country's foreign exchange rate, and thus of the potential for a firm
trading with or investing in that country to experience foreign exchange gains or losses. Changes
in the BOP may predict the imposition or removal of foreign exchange controls. 2) Changes in a
country's BOP may signal the imposition or removal of controls over payment of dividends and
interest, license fees, royalty fees, or other cash disbursements to foreign firms or investors. 3)
The BOP helps to forecast a country's market potential, especially in the short run. A country
experiencing a serious trade deficit is not as likely to expand imports as it would be if running a
surplus. It may, however, welcome investments that increase its exports.
Diff: 2
L.O.: 3.1 Fundamentals of BOP Accounting
Skill: Conceptual
AACSB: Application of knowledge
3.2 The Accounts of the Balance of Payments
1) Which of the following is NOT a part of the Current Account of BOP?
A) net export/import of goods
B) balance of trade
C) net portfolio investment
D) net export/import of services
Answer: C
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT part of the Financial Account of the BOP?
A) net foreign direct investment
B) net import/export of services
C) net portfolio investment
D) other Financial items
Answer: B
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
3) Which of the following is NOT part of the balance of payments account?
A) the current account
B) the financial/capital account
C) the official reserves account
D) All of the above are BOP accounts.
Answer: D
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
4) The ________ includes all international economic transactions with income or payment flows
occurring within the year.
A) capital account
B) current account
C) financial account
D) IMF account
Answer: B
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
5) If your company were to import and export textiles, the transactions would be recorded in the
current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.
Answer: C
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
6) The travel services provided to international travelers by United Airlines would be recorded in
the current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.
Answer: A
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
7) Anaconda Copper Inc. created a subsidiary in Chile last year to mine copper ore. The
proportion of net income paid back to the parent company as a dividend would be recorded in the
current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.
Answer: B
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
8) The subcategory that typically dominates the current account is:
A) goods (merchandise) trade.
B) services trade.
C) income trade.
D) transfer accounts.
Answer: A
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
9) In 2016 the United States posted a current account deficit. The bulk of the negative value
came from:
A) a net transfer deficit.
B) an income balance deficit.
C) a goods trade deficit.
D) an income trade deficit.
Answer: C
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
10) Over the last two decades the surplus on U.S. services trade has typically been ________ the
deficit on U.S. goods trade.
A) greater than
B) equal to
C) less than
D) The relationship is constantly shifting from greater than to less than.
Answer: C
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
11) The ________ of the balance of payments measures all international economic transactions
of financial assets.
A) current account
B) merchandise trade account
C) services account
D) capital and financial accounts
Answer: D
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
12) The financial account consists COMPLETELY of which four components?
A) stock investment, bond investment, derivative investment, and mutual fund investment
B) direct investment, stock investment, net financial derivatives, and bond investment
C) direct investment, portfolio investment, net financial derivatives, and other asset investment
D) mutual fund investment, portfolio investment, derivative investment, and stock investment
Answer: C
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
13) When categorizing investments for the financial account component of the balance of
payments the ________ is an investment where the investor has no control whereas the
________ is an investment where the investor has control over the asset.
A) direct investment; portfolio investment
B) direct investment; indirect investment
C) portfolio investment; indirect investment
D) portfolio investment; direct investment
Answer: D
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
14) In general, there is consensus that ________ should be free, but there is no such consensus
that ________ should be free.
A) international investment; international goods trade
B) international investment; international trade
C) international trade; international goods trade
D) international trade; international investment
Answer: D
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
15) The two major concerns about foreign direct investment are:
A) national defense and taxes.
B) who controls the assets and who receives the profits.
C) who receives the profits and taxes.
D) who pays the taxes and who receives the taxes.
Answer: B
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
16) Portfolio investment is capital invested in activities that are ________ rather than made for
________.
A) short term; the long term
B) long term; profit
C) profit motivated; control
D) control motivated; profit
Answer: C
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
17) Consider the following: A foreign automobile company builds a manufacturing plant in
Tennessee and European investors buy U.S. Treasury Bonds.
A) Both activities would be considered direct investment.
B) Both activities would be considered portfolio investment.
C) The auto manufacturer in engaging in portfolio investment, and the European investors are
engaged in direct investing.
D) The auto manufacturer in engaging in direct investment, and the European investors are
engaged in portfolio investing.
Answer: D
Diff: 2
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
18) China is currently experiencing a surplus in its current account and its capital/financial
accounts. Which of the following is NOT a contributing factor for this unusual situation?
A) The exceptional growth in the Chinese economy contributes to the current account surplus.
B) The positive prospects for China's continued growth contribute to the capital/financial
account surplus.
C) China's inevitable acquisition of Taiwan is driving the market for Chinese investment.
D) All of the above are contributing factors for China's twin surpluses.
Answer: C
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
19) If China wished to reduce their accumulation of foreign exchange reserves they could:
A) allow their currency, the yuan, to float freely in the market place.
B) reduce their current account surplus by importing more goods than they export.
C) undertake both of the activities identified in choices A and B.
D) dig a big hole and bury the reserves.
Answer: C
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
20) The largest single component of the United States current account is:
A) current transfers.
B) income payments and receipts.
C) goods (merchandise) imports and exports.
D) services imports and exports.
Answer: C
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
21) In general, as a country's income increases, so does the demand for imports.
Answer: TRUE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
22) For at least the last decade, the United States has consistently run a surplus in services trade
income.
Answer: TRUE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
23) Expenditures by U.S. students abroad and foreign students pursuing studies in the United
States would be considered a services trade and part of the U.S. current account.
Answer: TRUE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
24) International debt security purchases and sales are defined as portfolio investments for
financial account purposes because by definition debt securities do not provide the buyer with
ownership or control.
Answer: TRUE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
25) Significant amounts of United States Treasury issues are purchased by foreign investors;
therefore, the U.S. must earn foreign currency to repay this debt.
Answer: FALSE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
26) In the United States and most developed countries, the current account and the combined
financial/capital accounts tend to be inversely related in that when one is positive, the other tends
to be negative.
Answer: TRUE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
27) The biggest problem that China faces in maintaining a stable value for their currency, the
yuan, is their lack of foreign exchange reserves.
Answer: FALSE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
28) As of year-end 2016, the United States still held the world's largest foreign exchange reserve,
but the total was rapidly being approached by China.
Answer: FALSE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
29) China's current political plan includes reducing their foreign exchange reserve balance by
allowing the yuan to float freely and by switching their goods balance from one of a net surplus
to a net deficit.
Answer: FALSE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Recognition
AACSB: Application of knowledge
30) An excess of merchandise exports over merchandise imports results in a balance of trade
deficit.
Answer: FALSE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
31) The transition to floating exchange rate regimes in the 1970s (described in Chapter .3)
changed the focus from the total BOP to its various subaccount like the current and financial
account balances.
Answer: TRUE
Diff: 1
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
32) What is a country's balance of (merchandise) trade, and why is it so widely reported in the
financial and popular press?
Answer: The balance of trade (BOT) is the largest and most important subset of a country's
current account. It measures the difference in a country's imports and exports over a specified
time period. It is often reported because it is intuitively easy to understand (i.e., we either sell
more or buy more from foreign countries) and it is a reasonable representation of the total current
account balance. (For example, for the U.S. the BOT was -$343B in 1999 while the current
account balance was -$807B in 2017.
Diff: 3
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
33) What is the Official Reserves Account (ORA), and why is it more important for countries
under a fixed exchange rate regime than for ones under a floating exchange rate regime?
Answer: The ORA is the total reserves held by official monetary authorities within the country.
Under a fixed exchange regime, a country's currency is convertible into a fixed amount of
another country's currency. To keep the relationship between currencies at equilibrium, it may
become necessary for the government to buy or sell official reserves until the equilibrium is
restored. Under a variable rate regime this is not necessary as exchange rates are allowed to
change and official reserves no longer serve the same purpose as under the fixed rate regime.
Diff: 3
L.O.: 3.2 The Accounts of the Balance of Payments
Skill: Conceptual
AACSB: Application of knowledge
3.3 The BOP Impacts on Key Macroeconomic Rates
1) Under an international regime of fixed exchange rates, countries with a BOP ________ should
consider ________ their currency while countries with a BOP ________ should consider
________ their currency.
A) deficit, revaluing; surplus, revaluing
B) deficit, devaluing; surplus, devaluing
C) surplus, devaluing; deficit, revaluing
D) surplus, revaluing; deficit, devaluing
Answer: D
Diff: 2
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Analytical
AACSB: Analytical thinking
2) Use the following terms for this question:
C = consumption
I = capital investment spending
G = government spending
X = exports of goods and services
M = imports of goods and services
BOP = balance of payments
GDP = gross domestic product
NPV = net present value
INF = inflation
R = real rate of return
The static equation for the nations GDP is:
A) GDP = C + I + G + (X + M ) × INF
B) GDP = C + I + G + X + M
C) GDP = C + I + G + X - M
D) GDP = C + I + X - M + R
Answer: C
Diff: 2
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Analytical
AACSB: Analytical thinking
3) Use the following terms for this question:
(X-M) = Current Account Balance
(CI-CO) = Capital Account Balance
(FI-FO) = Financial Account Balance
(I-S) = Investment-Saving Balance
FXB = Reserve Balance
BOP = balance of payments
GDP = gross domestic product
C = consumption
I = capital investment spending
G = government spending
The static equation for the BOP is:
A) BOP = (X-M) - (CI-CO) - (FI-FO) + FXB
B) BOP = (X-M) + (I-S) + (FI-FO) + FXB
C) BOP = (X-M) + (CI-CO) + (FI-FO) + FXB
D) BOP = GDP - [C + I +G] + (FI-FO)
Answer: C
Diff: 2
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Analytical
AACSB: Analytical thinking
4) Imports have the potential to lower a country's inflation rate because of each of the following
EXCEPT:
A) the import of lower priced goods limits what domestic competitors can charge for goods.
B) the import of lower priced services limits what domestic competitors can charge for services.
C) the higher prices of foreign goods spurs domestic competitors to cut prices.
D) all of the above
Answer: C
Diff: 2
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Recognition
AACSB: Application of knowledge
5) Under a fixed exchange rate system, the government bears the responsibility to ensure that the
BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the
government is expected to intervene in the foreign exchange market by buying or selling official
foreign exchange reserves. If the sum of the first two accounts is GREATER THAN ZERO, a
________ demand for the domestic currency exists in the world. To preserve the fixed exchange
rate, the government must then intervene in the foreign exchange market and ________ domestic
currency for foreign currencies or gold so as to bring the BOP back near zero.
A) surplus; sell
B) surplus; buy
C) deficit; sell
D) deficit; buy
Answer: A
Diff: 2
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Conceptual
AACSB: Application of knowledge
6) Under a fixed exchange rate system, the government bears the responsibility to ensure that the
BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the
government is expected to intervene in the foreign exchange market by buying or selling official
foreign exchange reserves. If the sum of the first two accounts is LESS THAN ZERO, a
________ demand for the domestic currency exists in the world. To preserve the fixed exchange
rate, the government must then intervene in the foreign exchange market and ________ domestic
currency for foreign currencies or gold so as to bring the BOP back near zero.
A) surplus; sell
B) surplus; buy
C) deficit; sell
D) deficit; buy
Answer: D
Diff: 2
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Conceptual
AACSB: Application of knowledge
7) An increase in GDP should lead to a decrease in imports.
Answer: FALSE
Diff: 1
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Recognition
AACSB: Application of knowledge
8) The effect of an imbalance in the BOP is the same for countries on a fixed exchange rate
regime as for those on a floating exchange rate regime.
Answer: FALSE
Diff: 1
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Recognition
AACSB: Application of knowledge
9) Under a floating exchange rate system, the government bears the responsibility to ensure that
the BOP is near zero.
Answer: FALSE
Diff: 1
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Recognition
AACSB: Application of knowledge
10) A country with a managed float that wishes to WEAKEN its currency may choose to raise
domestic interest rates to attract additional capital from abroad.
Answer: FALSE
Diff: 1
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Conceptual
AACSB: Application of knowledge
11) A country's overall level of interest rates should have an impact on the financial account of
the BOP. Relatively low real interest rates should normally stimulate an outflow of capital
seeking higher interest rates in other country currencies.
Answer: TRUE
Diff: 1
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Conceptual
AACSB: Application of knowledge
12) Imports have the potential to lower a country's inflation rate. In particular, imports of
HIGHER-priced goods and services place a limit on what domestic competitors charge for
comparable goods and services.
Answer: FALSE
Diff: 1
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Recognition
AACSB: Application of knowledge
13) Very often governments seek to alter the market's valuation of their currency by influencing
relative interest rates, thus influencing the economic fundamentals of exchange rate
determination rather than through direct intervention in the foreign exchange markets. Describe
how this strategy works. Describe the case of the U.S. or China where the opposite effect, to the
suggest here, have occurred.
Answer: A country may choose to raise domestic interest rates to attract additional capital from
abroad (the short-term portfolio component of these capital flows). This step will alter market
forces and create additional market demand for the domestic currency in order to restore an
imbalance caused by the deficit in the current account. The process also raises the cost of local
borrowing for businesses so the policy is seldom without domestic negative consequences.
Relatively low real interest rates should normally stimulate an outflow of capital seeking higher
interest rates in other country currencies. However, in the case of the United States, the opposite
effect has occurred. Despite relatively low real interest rates and large BOP deficits on the
current account, the U.S. BOP financial account has experienced offsetting financial inflows due
to relatively attractive U.S. growth rate prospects, high levels of productive innovation, and
perceived political safety. Thus, the financial account inflows have helped the United States to
maintain its lower interest rates and to finance its exceptionally large fiscal deficit. However, it is
beginning to appear that the favorable inflow on the financial account is diminishing while the
U.S. balance on the current account is worsening.
Diff: 1
L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates
Skill: Conceptual
AACSB: Application of knowledge
3.4 Trade Balances and Exchange Rates
1) Of the following, which is NOT a part of J-Curve adjustment path?
A) the currency contract period
B) the exchange rate pass-through period
C) the quantity adjustment period
D) Each of the above is part of the J-Curve adjustment path.
Answer: D
Diff: 1
L.O.: 3.4 Trade Balances and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT likely to occur in the quantity adjustment phase of the J-Curve
adjustment path?
A) Imports become relatively more expensive.
B) Exports become relatively less expensive.
C) The balance of trade gets worse.
D) All of the above are true.
Answer: C
Diff: 2
L.O.: 3.4 Trade Balances and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
3) When a currency is devalued, the immediate impact may be an increase in a country's trade
deficit. However, this situation tends to correct itself in 2 to 5 weeks.
Answer: FALSE
Diff: 2
L.O.: 3.4 Trade Balances and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
4) The immediate impact of a devaluation of the domestic currency is to decrease the value of
the spot exchange rate S$/fc.
Answer: FALSE
Diff: 2
L.O.: 3.4 Trade Balances and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
5) Countries occasionally intentionally devalue their currencies. So what is the logic and likely
results of intentionally devaluing their domestic currency? International economic analysis
characterizes the trade balance adjustment process as occurring in three stages. List and explain
the three stages too.
Answer: International economic analysis characterizes the trade balance adjustment process as
occurring in three stages: 1) the currency contract period; 2) the pass-through period; and 3) the
quantity adjustment period. Assuming that the trade balance is already in deficit prior to the
devaluation, a devaluation at time results initially in a further deterioration in the trade balance
before an eventual improvement. The path of adjustment, as shown, takes on the shape of a
flattened "j."
In the currency contract period, a sudden unexpected devaluation of the domestic currency will
deteriorate the trade balance simply because all the contracts for exports and imports are already
in effect. Firms operating under these agreements are required to fulfill their obligations,
regardless of whether they profit or suffer losses. In the pass-through period, as exchange rates
change, importers and exporters eventually must pass these exchange rate changes through to
their own product prices. Import prices rise and export prices are now cheaper compared to
foreign competitors' because the dollar is cheaper. The third and final period, the quantity
adjustment period, achieves the balance of trade adjustment that is expected from a domestic
currency devaluation or depreciation. As the import and export prices change as a result of the
pass-through period, consumers both in the United States and in the U.S. export markets adjust
their demands to the new prices. Imports are relatively more expensive; therefore, the quantity
demanded decreases. Exports are relatively cheaper; therefore, the quantity demanded increases.
The balance of trade—the expenditures on exports less the expenditures on imports—improves.
Diff: 2
L.O.: 3.4 Trade Balances and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
3.5 Capital Mobility
1) The authors identify four distinct periods of capital mobility since 1860. Which do they term
as a "period of global economic destruction"?
A) 1860 - 1914
B) 1914 - 1945
C) 1945 - 1971
D) 1971 - 2007
Answer: B
Diff: 2
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
2) ________ is the cross-border purchase of assets that are then managed in a way that hides the
movement of money and its ownership.
A) Capital flight
B) Capital mobility
C) Irrational exuberance
D) Money laundering
Answer: D
Diff: 1
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
3) This was an era dominated by industrialized nation economies that were dependent on gold
convertibility to maintain confidence in the system.
A) The Gold Standard, 1860-1914
B) The Interwar Years, 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997
Answer: A
Diff: 1
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
4) This dollar-based fixed exchange rate system gave rise to a long period of economic recovery
and growing openness of both international trade and capital flows in and out of more and more
countries.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997
Answer: C
Diff: 1
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
5) An era of retrenchment, in which major economic powers returned to policies of isolationism
and protectionism, restricting trade and nearly eliminating capital mobility.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997
Answer: B
Diff: 1
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
6) A ________ is any restriction that limits or alters the rate or direction of capital movement
into or out of a country.
A) capital budget
B) capital control
C) balance of trade deficit
D) balance of trade surplus
Answer: B
Diff: 1
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
7) Long-term capital flows reflect the following factors EXCEPT:
A) short-term interest rate differentials.
B) fundamental economic expectations.
C) growth prospects.
D) perceptions of political stability.
Answer: A
Diff: 1
L.O.: 3.5 Capital Mobility
Skill: Conceptual
AACSB: Application of knowledge
8) Capital controls may take a variety of forms EXCEPT:
A) currency boards.
B) taxes.
C) quotas.
D) prohibitions.
Answer: A
Diff: 1
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
9) The Bretton Woods era realized a great expansion of international trade in goods and services.
Answer: TRUE
Diff: 2
L.O.: 3.5 Capital Mobility
Skill: Recognition
AACSB: Application of knowledge
10) Longer-term capital flows reflect short-term interest rate differentials and exchange rate
expectations.
Answer: FALSE
Diff: 2
L.O.: 3.5 Capital Mobility
Skill: Conceptual
AACSB: Application of knowledge
11) One of the motivations for capital controls is to insulate an economy from foreign political
risks.
Answer: FALSE
Diff: 2
L.O.: 3.5 Capital Mobility
Skill: Conceptual
AACSB: Application of knowledge
12) Dutch Disease is a term applied to a problem in the 1970 whereby the Netherlands were
experiencing massive and sudden inflows of capital from abroad. What was the cause of this
sudden influx of capital, and what types of potential problems did it have for the Dutch or could
it have for any small single resource country?
Answer: With the rapid growth of the natural gas industry in the Netherlands in the 1970s, there
was growing fear that massive capital inflows would drive up the demand for the Dutch guilder
and cause a substantial currency appreciation. A more expensive guilder would then reduce the
international competitiveness of other Dutch manufacturing industries, causing their relative
decline to that of the natural resource industry. This is a challenge faced by a number of
resource-rich economies of relatively modest size and relatively small export sectors.
Diff: 2
L.O.: 3.5 Capital Mobility
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 4 Financial Goals and Corporate Governance
4.1 Business Ownership
1) Foreign stock markets are frequently characterized by controlling shareholders for the
individual publicly traded firms. Which of the following is NOT identified by the authors as
typical controlling shareholders?
A) the government (for example, privatized utilities)
B) institutions (such as banks in Germany)
C) family (such as in France)
D) All of the above were identified by the authors as controlling shareholders.
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT typically associated with the public ownership of business
organizations?
A) the state
B) the government
C) families
D) civil society
Answer: C
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
3) Which of the following is NOT typically associated with the private ownership of business
organizations?
A) the government
B) families
C) individuals
D) publicly traded, widely-held organizations
Answer: A
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
4) State Owned Enterprises (SOEs):
A) are a form of public ownership.
B) are created for commercial activities rather than civil or social activities.
C) are the dominant form of business organization in some countries.
D) are all of the above.
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
5) The problems that may arise due to the separation of ownership and management in large
business organizations are known as:
A) separation anxiety.
B) the agency problem.
C) corporate disconnect theory.
D) none of the above
Answer: B
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
6) Privatization is a term used to describe:
A) firms that are purchased by the government.
B) government operations that are purchased by corporations and other investors.
C) firms that do not use publicly available debt.
D) non-public meetings held by members of interlocking directorates.
Answer: B
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
7) "Maximize corporate wealth":
A) is the primary objective of the non-Anglo-American model of management.
B) as a management objective treats shareholders on a par with other corporate stakeholders such
as creditors, labor, and local community.
C) has a broader definition than just financial wealth.
D) all of the above
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
8) The Shareholder Wealth Maximization Model (SWM):
A) combines the interests and inputs of shareholders, creditors, management, employees, and
society.
B) is being usurped by the Stakeholder Capitalism Model as those types of MNEs dominate their
global industry segments.
C) clearly places shareholders as the primary stakeholder.
D) is the dominant form of corporate management in the European-Japanese governance system.
Answer: C
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
9) The Stakeholder Capitalism Model (SCM):
A) clearly places shareholders as the primary stakeholder.
B) combines the interests and inputs of shareholders, creditors, management, employees, and
society.
C) has financial profit as its goal and is often termed impatient capital.
D) is the Anglo-American model of corporate governance.
Answer: B
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
10) In the Anglo-American model of corporate governance, the primary goal of management is
to:
A) maximize the wealth of all stakeholders.
B) maximize shareholder wealth.
C) minimize costs.
D) minimize risk.
Answer: B
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
11) In finance, an efficient market is one in which:
A) prices are assumed to be correct.
B) prices adjust quickly and accurately to new information.
C) prices are the best allocators of capital in the macro economy.
D) all of the above
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
12) Systematic risk can be defined as:
A) the total risk to the firm.
B) the risk of the individual security.
C) the risk of the market in general.
D) the risk that can be systematically diversified away.
Answer: C
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
13) Unsystematic risk can be defined as:
A) the total risk to the firm.
B) the risk of the individual security.
C) the added risk that a firm's shares bring to a diversified portfolio.
D) the risk of the market in general.
Answer: B
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
14) The study of how shareholders can motivate management to accept the prescriptions of the
shareholder wealth maximization model is called:
A) market efficiency.
B) the SWM model.
C) agency theory.
D) the SCM model.
Answer: C
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
15) Under the Shareholder Wealth Maximization Model (SWM) of corporate governance, poor
firm performance is likely to be faced with all but which of the following?
A) sale of shares by disgruntled current shareholders
B) shareholder activism to attempt a change in current management
C) as a maximum threat, initiation of a corporate takeover
D) prison time for executive management
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
16) Which of the following is a reason why managers act to maximize shareholder wealth in
Anglo-American markets?
A) the use of stock options to align the goals of shareholders and managers
B) the market for corporate control that allows for outside takeover of the firm
C) performance-based compensation for executive management
D) all of the above
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
17) Which of the following is NOT true regarding the stakeholder capitalism model?
A) Banks and other financial institutions are less important creditors than securities markets.
B) Labor unions are more powerful than in the Anglo-American markets.
C) Governments interfere more in the marketplace to protect important stakeholder groups.
D) All of the above are TRUE.
Answer: A
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
18) The stakeholder capitalism model:
A) typically avoids the flaw of impatient capital.
B) tries to meet the desires of multiple stakeholders.
C) may leave management without a clear signal about tradeoffs among the several stakeholders.
D) all of the above
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
19) Which of the following is generally NOT considered to be a viable operational goal for a
firm?
A) maintaining a strong local currency
B) maximization of after-tax income
C) minimization of the firm's effective global tax burden
D) correct positioning of the firm's income, cash flows and available funds as to country and
currency
Answer: A
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
20) Which of the following operational goals for the international firm may be incompatible with
the others?
A) maintaining a strong local currency
B) maximization of after-tax income
C) minimization of the firm's effective global tax burden
D) Each of these goals may be incompatible with one or more of the others.
Answer: D
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
21) The primary operational goal for the firm is to:
A) maximize after-tax profits in each country where the firm is operating.
B) minimize the total financial risk to the firm.
C) maximize the consolidated after-tax profits of the firm.
D) maximize the total risk to the firm.
Answer: C
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
22) With shareholder wealth maximization as the manager's goal, capital may be termed:
A) impatient.
B) patient.
C) borrowed.
D) bought.
Answer: A
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
23) If share price rises from $12 to $15 per share, and pays a dividend of $1 per share, what was
the rate of return to shareholders?
A) 26.67%
B) -13.33%
C) 33.33%
D) 16.67%
Answer: C
Diff: 3
L.O.: 4.1 Business Ownership
Skill: Analytical
AACSB: Analytical thinking
24) PolyProduction Inc. has two classes of common stock. Class A has 5 million shares with 10
votes per share. Class B has 5 million shares with 1 vote per share. If the dividends per share are
equal for both class A and B stock, then Class A shareholders have ________ of the votes and
________ of the dividends.
A) 90.91%; 90.91%
B) 90.91%; 50.00%
C) 50.00%; 50.00%
D) 83.33%; 33.33%
Answer: B
Diff: 3
L.O.: 4.1 Business Ownership
Skill: Analytical
AACSB: Analytical thinking
25) In the U.S. and U.K. stock markets are characterized by ownership of firms concentrated in
the hands of a few controlling shareholders. In contrast, the rest of the world tends to have more
widespread ownership of shares.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
26) State Owned Enterprises (SOEs) by their very name cannot be traded on stock exchanges
because they are government owned.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
27) According to recent research, family-owned firms in some highly-developed economies
typically outperform publicly-owned firms.
Answer: TRUE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
28) According to the authors, dual classes of voting stock are the norm in non-Anglo-American
markets.
Answer: TRUE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
29) In recent years the trend has been for markets to increasing focus on the shareholder wealth
form of wealth maximization.
Answer: TRUE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
30) Non-Anglo-American markets are dominated by the "one-vote-one-share" rule.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
31) The stakeholder capitalism model (SCM) holds that total risk (operational and financial) is
more important than just systematic risk.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
32) In recent years the trend has been for markets to increasing focus on the global stakeholders.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
33) Patient Capitalism is characterized by short-term focus by both management and investors.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
34) Agency theory states that unsystematic risk can be eliminated through diversification.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
35) The stakeholder capitalism model does not assume that equity markets are either efficient or
inefficient.
Answer: TRUE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
36) The stakeholder capitalism model assumes that only systematic risk "counts" or is a prime
concern for management.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
37) Dividend yield is the change in the share price of stock as traded in the public equity
markets.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
38) The goal of all international corporations is to maximize shareholder wealth.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
39) Systematic risk can be eliminated through portfolio diversification.
Answer: FALSE
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
40) A recent study shows that privately held firms use less financial leverage and enjoy lower
costs of debt than publicly traded firms.
Answer: TRUE
Diff: 2
L.O.: 4.1 Business Ownership
Skill: Recognition
AACSB: Application of knowledge
41) In the stakeholder capitalism model (SCM) the assumption of market efficiency is absolutely
critical.
Answer: FALSE
Diff: 2
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
42) One of the most challenging issues in the financial management of the enterprise is the
possible separation of ownership from management resulting in the so-called principal agent
problem. Define the agency problem, explain possible ways to alleviate the agency problem and
discuss differences in across global markets.
Answer: The separation of ownership from management raises the possibility that the two
entities may have different business and financial objectives. This is the so-called principal agent
problem. There are several strategies for aligning shareholder and management interests, the
most common of which is for senior management to own shares or share options. What is then
good for the managers' own personal wealth is similar to that of general shareholders.
The United States and United Kingdom are two country markets characterized by wide-spread
ownership of shares. Management may own some small portion of stock in their firms, but
largely management is a hired agent that is expected to represent the interests of shareholders. In
contrast, many firms in many other global markets are characterized by controlling shareholders
such as government, institutions (e.g., banks in Germany), family (e.g., in France, Italy, and
throughout Asia and Latin America), and consortiums of interests (e.g., keiretsus in Japan and
chaebols in South Korea). A business that is owned and managed by the same entity does not
suffer the agency problem.
Diff: 1
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
43) Describe the management objectives of a firm governed by the shareholder wealth
maximization model and one governed by the stakeholder wealth maximization model. Give an
example of how these two models may lead to different decision-making by executive
management.
Answer: Shareholder wealth maximization attempts to do just that, typically through the
maximization of share price. Stakeholder wealth maximization is much more difficult because of
the necessity to satisfy many stakeholders all having approximately equal claim on the objectives
of management. These stakeholders may include shareholders, creditors, customers, employees,
and community. Differing decisions may occur in a situation that involves significant social
costs. For example, in the U.S. the decision to shift production from a local factory to a foreign
one may be in large based on the change in NPV as the result of the move with only minor
consideration of the impact that a change in location would have on the community at large or
the local employees. A manager of a stakeholder driven firm may place equal or greater
emphasis on the local employees and community and choose to maintain the current facility
rather than move even if the foreign operation provided a much greater NPV. Ultimately, the
latter may cause an inefficient allocation of scarce resources and lead to an overall lower
standard of living.
Diff: 3
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
44) Define patient and impatient capitalism and discuss how each may lead to different decision-
making in the shareholder wealth maximization model.
Answer: Patient capitalism may be defined as a focus on long-term shareholder wealth
maximization and is often associated with management focusing on long-term investments with
less emphasis placed on short-term or trendy objectives. On the other hand, impatient capitalism
could be described as a destructive focus on the short term by both management and investors.
These differences in the time horizon could lead to different and perhaps inferior decisions by
existing management and ultimately be costly to the shareholders.
Diff: 3
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
45) What are the most important distinctions that make state owned enterprises (SOEs) different
from other forms of government organizations?
Answer: State owned enterprises are created distinctly for the purpose of commercial activities,
rather than the multitude of other social, civil, and regulatory activities of government. SOEs are
today, in many countries, the dominant form of business entity.
Diff: 2
L.O.: 4.1 Business Ownership
Skill: Conceptual
AACSB: Application of knowledge
4.2 Publicly Traded versus Privately Held: The Global Shift
1) The number of publicly traded firms:
A) peaked in the U.S. in 1996.
B) peaked worldwide in 1996.
C) increased significantly in 2009 as a result of the international financial crisis.
D) all of the above
Answer: A
Diff: 1
L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT a source of new stock exchange listing additions?
A) initial public offerings
B) movements of share listings from one exchange to another
C) spinouts from larger firms
D) All of the above are sources.
Answer: D
Diff: 1
L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift
Skill: Recognition
AACSB: Application of knowledge
3) Which of the following is NOT a delisting category?
A) forced delistings
B) mergers
C) acquisitions
D) All of the above are categories of delistings.
Answer: D
Diff: 1
L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift
Skill: Recognition
AACSB: Application of knowledge
4) U.S. listings of publicly traded firms as a percentage of worldwide listings of such firms
INCREASED from 11% in 1996 to approximately 33% in 2015.
Answer: FALSE
Diff: 1
L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift
Skill: Recognition
AACSB: Application of knowledge
5) Companies that are delisted cease to trade.
Answer: FALSE
Diff: 1
L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift
Skill: Recognition
AACSB: Application of knowledge
6) Since movements between exchanges typically are a zero sum within a country, and spinouts
and bulletin board movements are few in number, real growth in listings comes from IPOs.
Answer: FALSE
Diff: 1
L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift
Skill: Recognition
AACSB: Application of knowledge
7) The decline of share listings in the United States has led to considerable debate over whether
these trends represent a fundamental global business shift away from the publicly traded
corporate form, or something that is more U.S.-centric combined with the economic times.
Develop an argument to why the decline happened.
Answer: One recent study argued that it was not really the increasingly burdensome U.S.
regulatory environment that was to blame, but rather a proliferation of factors that caused the
decline in market making, sales, and research support for small and medium-sized equities.
Beginning with the introduction of online brokerage in 1996 and online trading rules in 1997,
more and more equity trading in the United States shifted to electronic communication networks
which allowed all market participants to trade directly with the exchange order books, and not
through brokers or brokerage houses. Although this increased competition reduced transaction
costs dramatically, it also undermined the profitability of the retail brokerage houses, which had
always supported research, market making, and sales and promotion of the small- to medium-
sized equities. Without this financial support, the smaller stocks were no longer covered and
promoted by the major equity houses. Without that research, marketing, promotion and coverage,
their trading volumes and values fell.
Diff: 1
L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift
Skill: Conceptual
AACSB: Application of knowledge
4.3 Corporate Governance
1) Which of the following broad topics is NOT identified as an area to be established as good
corporate governance practice by the Organization for Economic Cooperation and Development
(OECD)?
A) protect the rights of shareholders
B) disclosure and transparency
C) the proper role of stakeholders in the governance of the firm
D) All of the above should be a concern of good corporate governance.
Answer: D
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
2) The relationship among stakeholders used to determine and control the strategic direction and
performance of an organization is termed:
A) corporate governance.
B) Anglo-American activism.
C) capital structure.
D) working capital management.
Answer: A
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
3) When discussing the structure of corporate governance, the authors distinguish between
internal and external factors. ________ is an example of an internal factor, and ________ is an
example of an external factor.
A) Equity markets; executive management
B) Debt markets; board of directors
C) Executive management; auditors
D) Auditors; regulators
Answer: C
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT commonly associated with a government affiliated form of
corporate governance regime?
A) no minority influence
B) lack of transparency
C) state ownership of enterprise
D) All are associated with this type of corporate governance regime.
Answer: D
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
5) Generally speaking, which of the following is NOT considered an important factor in the
composition and control of corporate boards of directors?
A) the number of insider vs. outside directors
B) the total number of directors on the board
C) the composition of the compensation committee
D) All of the above are important factors of board composition.
Answer: D
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
6) Signed into law on July 30, 2002, the ________ Act requires CEOs of publicly traded
companies to vouch for the veracity of the firm's published financial statements.
A) Smoot-Hawley
B) Humphrey-Hawkins
C) McCain-Merrill
D) Sarbanes-Oxley
Answer: D
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
7) The Sarbanes-Oxley Act, passed by the U.S. Congress in July 2002, was designed to:
A) reinstitute heavy tariffs on international trade.
B) reform corporate governance.
C) limit the Federal Reserve Board's ability to engage in the buying and selling of gold.
D) limit trade with countries deemed lenient on terrorism.
Answer: B
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
8) Anglo-American markets is a term used to describe business markets in:
A) North, Central, and South America.
B) the United States, Canada, and Western Europe.
C) the United States, United Kingdom, Canada, Australia and New Zealand.
D) the United States, France, Britain, and Germany.
Answer: C
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
9) The deliberation of the of the process demonstrated in the European-Japanese system of
corporate governance has sometimes been termed:
A) socialism.
B) impatient capital.
C) patient capital.
D) communism.
Answer: C
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Conceptual
AACSB: Application of knowledge
10) Which of the following is NOT an important concept when distinguishing between
international and domestic financial management?
A) corporate governance
B) culture, history, and institutions
C) political risk
D) All of the above are important distinguishing concepts.
Answer: D
Diff: 2
L.O.: 4.3 Corporate Governance
Skill: Conceptual
AACSB: Application of knowledge
11) The Board of Directors:
A) consists exclusively of the officers of the corporation.
B) is the legal body which is accountable for the governance of the corporation.
C) are not subject to the external forces of the marketplace.
D) is appointed by the Securities and Exchange Commission (SEC).
Answer: B
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
12) Which of the following is NOT a possible and appropriate response by shareholders
dissatisfied with existing firm management of a publicly traded firm?
A) Shareholders could sell their shares of stock.
B) Shareholders could remain quietly disgruntled.
C) Shareholders, perhaps with the help of others, could attempt to initiate a takeover.
D) All of these responses may be possible and appropriate.
Answer: D
Diff: 2
L.O.: 4.3 Corporate Governance
Skill: Conceptual
AACSB: Application of knowledge
13) Regarding comparative corporate governance regimes: Bank-based regimes characterized by
government influence in bank lending and a lack of transparency is often found in countries such
as Korea and Germany.
Answer: TRUE
Diff: 2
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
14) Investor protection is typically better in countries with codified civil law (the Code
Napoleon) than in countries with a legal system based in English common law.
Answer: FALSE
Diff: 2
L.O.: 4.3 Corporate Governance
Skill: Conceptual
AACSB: Application of knowledge
15) The relatively low cost of compliance with the Sarbanes-Oxley Act (SOX) has been a
surprising benefit of the act.
Answer: FALSE
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Recognition
AACSB: Application of knowledge
16) Having Anglo-Americans as members of the board of directors of a non-Anglo-American
firm signals poor corporate governance in the firm.
Answer: FALSE
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Conceptual
AACSB: Application of knowledge
17) Although there are many different cultural and legal approaches used in corporate
governance worldwide, there is a growing consensus on what constitutes good corporate
governance. List and explain at least three standardized common principles of good corporate
governance.
Answer: 1) A board of directors that has both internal and external members. More importantly,
it should be staffed by individuals of true experience and knowledge of not only their own rules
and responsibilities, but of the nature and conduct of the corporate business. 2) A management
compensation system that is aligned with corporate performance (financial and otherwise) and
has significant oversight from the board and open disclosure to shareholders and investors. 3)
Independent auditing of corporate financial results on a meaningful real-time basis. An audit
process with oversight by a Board committee composed primarily of external members would be
an additional significant improvement. 4) Timely public reporting of both financial and
nonfinancial operating results that may be used by investors to assess the investment outlook.
This should also include transparency and reporting around potentially significant liabilities.
Diff: 1
L.O.: 4.3 Corporate Governance
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 5 The Foreign Exchange Market
5.1 Functions of the Foreign Exchange Market
1) Which of the following is NOT true regarding the market for foreign exchange?
A) The market provides the physical and institutional structure through which the money of one
country is exchanged for another.
B) The rate of exchange is determined in the market.
C) Foreign exchange transactions are physically completed in the foreign exchange market.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
2) A/An ________ is an agreement between a buyer and seller that a fixed amount of one
currency will be delivered at a specified rate for some other currency.
A) Eurodollar transaction
B) import/export exchange
C) foreign exchange transaction
D) interbank market transaction
Answer: C
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
3) The ________ is the mechanism by which participants transfer purchasing power between
countries, obtain or provide credit for international trade transactions, and minimize exposure to
the risks of exchange rate changes.
A) futures market
B) federal open market
C) foreign exchange market
D) LIBOR
Answer: C
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT a motivation identified by the authors as a function of the
foreign exchange market?
A) the transfer of purchasing power between countries
B) obtaining or providing credit for international trade transactions
C) minimizing the risks of exchange rate changes
D) All of the above were identified as functions of the foreign exchange market.
Answer: D
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
5) Business firms in countries with exchange controls, for example, China (mainland), often
must surrender foreign exchange earned from exports to the central bank at the daily fixing price.
Answer: TRUE
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
6) The foreign exchange market provides the physical and institutional structure through which
three typical functions are accomplish. List and explain three functions of the foreign exchange
market.
Answer: The foreign exchange market is the mechanism by which participants transfer
purchasing power between countries by exchanging money, obtain or provide credit for
international trade transactions, and minimize exposure to the risks of exchange rate changes.
1) The transfer of purchasing power is necessary because international trade and capital
transactions normally involve parties living in countries with different national currencies.
Usually each party wants to deal in its own currency, but the trade or capital transaction can be
invoiced in only one currency. Hence, one party must deal in a foreign currency. 2) Because the
movement of goods between countries takes time, inventory in transit must be financed. The
foreign exchange market provides a source of credit. Specialized instruments, such as bankers'
acceptances and letters of credit are available to finance international trade. 3) The foreign
exchange market provides "hedging" facilities for transferring foreign exchange risk to someone
else more willing to carry risk.
Diff: 1
L.O.: 5.1 Functions of the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge
5.2 Structure of the Foreign Exchange Market
1) While trading in foreign exchange takes place worldwide, the major currency trading centers
are located in:
A) London, New York, and Tokyo.
B) New York, Zurich, and Bahrain.
C) Paris, Frankfurt, and London.
D) Los Angeles, New York, and London.
Answer: A
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
2) The authors identify two tiers of foreign exchange markets:
A) bank and nonbank foreign exchange.
B) commercial and investment transactions.
C) interbank and client markets.
D) client and retail market.
Answer: C
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
3) It is characteristic of foreign exchange dealers to:
A) bring buyers and sellers of currencies together but never to buy and hold an inventory of
currency for resale.
B) act as market makers, willing to buy and sell the currencies in which they specialize.
C) trade only with clients in the retail market and never operate in the wholesale market for
foreign exchange.
D) All of the above are characteristics of foreign exchange dealers.
Answer: B
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following may be participants in the foreign exchange markets?
A) bank and nonbank foreign exchange dealers
B) central banks and treasuries
C) speculators and arbitrageurs
D) all of the above
Answer: D
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
5) ________ seek to profit from trading in the market itself rather than having the foreign
exchange transaction being incidental to the execution of a commercial or investment
transaction.
A) Speculators and arbitrageurs
B) Foreign exchange brokers
C) Central banks
D) Treasuries
Answer: A
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
6) In the foreign exchange market, ________ seek all of their profit from exchange rate changes
while ________ seek to profit from simultaneous exchange rate differences in different markets.
A) wholesalers; retailers
B) central banks; treasuries
C) speculators; arbitrageurs
D) dealers; brokers
Answer: C
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
7) Foreign exchange ________ earn a profit by a bid-ask spread on currencies they purchase and
sell. Foreign exchange ________, on the other hand, earn a profit by bringing together buyers
and sellers of foreign currencies and earning a commission on each sale and purchase.
A) central banks; treasuries
B) dealers; brokers
C) brokers; dealers
D) speculators; arbitrageurs
Answer: B
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
8) ________ are agents who facilitate trading between dealers without themselves becoming
principals in the transaction.
A) Central banks
B) Foreign exchange brokers
C) Arbitrageurs
D) Foreign exchange dealers
Answer: B
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
9) Because the market for foreign exchange is worldwide, the volume of foreign exchange
currency transactions is level throughout the 24-hour day.
Answer: FALSE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
10) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement
at Bretton Woods.
Answer: FALSE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge
11) Dealers in foreign exchange departments at large international banks act as market makers
and maintain inventories of the securities in which they specialize.
Answer: TRUE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
12) Currency trading lacks profitability for large commercial and investment banks but is
maintained as a service for corporate and institutional customers.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
13) The primary motive of foreign exchange activities by most central banks is profit.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
14) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank
markets.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
15) Dealers in the foreign exchange departments of large international banks often function as
"market makers." Such dealers stand willing at all times to buy and sell those currencies in which
they specialize and thus maintain an "inventory" position in those currencies.
Answer: TRUE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
16) Currency trading is a service center rather than a profit center for commercial and investment
banks.
Answer: FALSE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
17) For individuals and firms involved in the import and export of goods and services, using the
foreign exchange market is necessary, but incidental, to their underlying commercial or
investment purpose.
Answer: TRUE
Diff: 2
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
18) Most transactions in the interbank foreign exchange trading are primarily conducted via
telecommunication techniques and little is conducted face-to-face.
Answer: TRUE
Diff: 1
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
19) What are some of the reasons central banks and treasuries enter the foreign exchange
markets, and in what important ways are they different from other foreign exchange participants?
Answer: Central banks and treasuries enter the foreign exchange market to acquire/spend their
own foreign exchange reserves and to influence the price at which their own currency is traded.
Unlike other market participants, they are not profit oriented. Instead, they may willingly take a
loss if they think it is in their best national interest.
Diff: 3
L.O.: 5.2 Structure of the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge
5.3 Transactions in the Foreign Exchange Market
1) ________ is NOT one of the three categories reported for foreign exchange.
A) Spot transactions
B) Swap transactions
C) Strip transactions
D) Futures transactions
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
2) A ________ transaction in the foreign exchange market requires an almost immediate delivery
(typically within two days) of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above
Answer: A
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
3) A ________ transaction in the foreign exchange market requires delivery of foreign exchange
at some future date.
A) spot
B) forward
C) swap
D) currency
Answer: B
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
4) A forward contract to deliver British pounds for U.S. dollars could be described either as
________ or ________.
A) buying dollars forward; buying pounds forward
B) selling pounds forward; selling dollars forward
C) selling pounds forward; buying dollars forward
D) selling dollars forward; buying pounds forward
Answer: C
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge
5) A common type of swap transaction in the foreign exchange market is the ________ where
the dealer buys the currency in the spot market and sells the same amount back to the same bank
in the forward market.
A) "forward against spot"
B) "forspot"
C) "repurchase agreement"
D) "spot against forward"
Answer: D
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
6) The ________ is a derivative forward contract that was created in the 1990s. It has the same
characteristics and documentation requirements as traditional forward contracts except that they
are only settled in U.S. dollars and the foreign currency involved in the transaction is not
delivered.
A) nondeliverable forward
B) dollar only forward
C) virtual forward
D) internet forward
Answer: A
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
7) Which of the following is NOT true regarding nondeliverable forward (NDF) contracts?
A) NDFs are used primarily for emerging market currencies.
B) Pricing of NDFs reflects basic interest rate differentials plus an additional premium charged
for dollar settlement.
C) NDFs can only be traded by central banks.
D) All of the above are true.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge
8) A ________ transaction in the interbank market is the simultaneous purchase and sale of a
given amount of foreign exchange for two different value dates.
A) spot
B) forward-forward
C) swap
D) futures
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
9) Daily trading volume in the foreign exchange market was about ________ per ________ in
2015.
A) $5,100 billion; month
B) $3,100 billion; month
C) $5,100 billion; day
D) $3,100 billion; day
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
10) The greatest volume of daily foreign exchange transactions are:
A) spot transactions.
B) forward transactions.
C) swap transactions.
D) This question is inappropriate because the volume of transactions are approximately equal
across the three categories above.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
11) The United Kingdom and United States together make up nearly ________ of daily currency
trading.
A) 30%
B) 40%
C) 50%
D) 60%
Answer: D
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
12) The top three currency pairs traded with the U.S. dollar are:
A) U.K. pound, Chinese Yuan, Japanese yen.
B) Swiss franc, euro, Japanese yen.
C) U.K. pound, euro, Japanese yen.
D) euro, Chinese Yuan, Japanese yen.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
13) The greatest amount of foreign exchange trading takes place in the following three cities:
A) New York, London, and Tokyo.
B) New York, Singapore, and London.
C) London, Frankfurt, and Paris.
D) London, Tokyo, and Zurich.
Answer: B
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
14) The four currencies that constitute about 80% of all foreign exchange trading are:
A) U.K pound, Chinese yuan, euro, and Japanese yen.
B) U.S. dollar, euro, Chinese yuan, and U.K. pound.
C) U.S. dollar, Japanese yen, euro, and U.K. pound.
D) U.S. dollar, U.K. pound, yen, and Chinese yuan.
Answer: C
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
15) A spot transaction in the interbank market for foreign exchange would typically involve a
two-day delay in the actual delivery of the currencies, while such a transaction between a bank
and its commercial customer would not necessarily involve a two-day wait.
Answer: TRUE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
16) Nondeliverable Forwards were originally envisioned as a method of currency speculation,
but it is now estimated that 70% of NDFs are trading for hedging purposes.
Answer: FALSE
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
17) In general, NDF markets normally develop for country currencies having large cross-border
capital movements, but still subject to convertibility restrictions.
Answer: TRUE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge
18) NDFs are traded and settled inside the country of the subject currency, and therefore are
within the control of the country's government.
Answer: FALSE
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
19) A contract to deliver dollars for euros in six months is both "buying euros forward for
dollars" and "selling dollars forward for euros."
Answer: TRUE
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
20) As you might expect, the foreign exchange daily trading volume in in New York City is
roughly twice as large as the daily trading volume in London.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
21) The low level of interest rates around the globe in recent years, combined with slowing
economic growth and new debt issuances, has had a dampening impact on the swap market.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
22) Since the global financial crisis of 2008-2009, the Chinese renminbi (yuan) has become the
most widely traded currency with the U.S. dollar surpassing the euro, yen, and pound as dollar
trading pairs.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
23) Swap and forward transactions account for an insignificant portion of the foreign exchange
market.
Answer: FALSE
Diff: 1
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Recognition
AACSB: Application of knowledge
24) Define spot, forward, and swap transactions in the foreign exchange market and give an
example of how each could be used.
Answer: Spot transactions are exchanging one currency for another right now. Spot transactions
are typically entered into because the parties need to exchange foreign currencies that they have
received into their domestic currency, or because they have an obligation that requires them to
obtain foreign currency.
Forward foreign exchange transactions are agreements entered into today to exchange currencies
at a particular price at some point in the future. Forwards may be speculative or a hedge against
unexpected changes in the price of the other currency.
Swaps are the simultaneous purchase and sale of a given amount of a foreign exchange for two
different dates. Both transactions are conducted with the same counterparty. A swap may be
considered a technique for borrowing another currency on a fully collateralized basis.
Diff: 2
L.O.: 5.3 Transactions in the Foreign Exchange Market
Skill: Conceptual
AACSB: Application of knowledge
5.4 Foreign Exchange Rates and Quotations
1) A foreign exchange ________ is the price of one currency expressed in terms of another
currency. A foreign exchange ________ is a willingness to buy or sell at the announced rate.
A) quote; rate
B) quote; quote
C) rate; quote
D) rate; rate
Answer: C
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
2) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed
as the foreign currency per dollar this known as ________ whereas ________ are expressed as
dollars per foreign unit.
A) European terms; indirect
B) American terms; direct
C) American terms; European terms
D) European terms; American terms
Answer: D
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
3) The following is an example of an American term foreign exchange quote:
A) $20/£
B) 0.85/$
C) ¥100/
D) none of the above
Answer: A
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
4) From the viewpoint of a British investor, which of the following would be a direct quote in the
foreign exchange market?
A) SF2.40/£
B) $1.50/£
C) £0.55/
D) $0.90/
Answer: C
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
5) A/an ________ quote in the United States would be foreign units per dollar, while a/an
________ quote would be in dollars per foreign currency unit.
A) direct; direct
B) direct; indirect
C) indirect; indirect
D) indirect; direct
Answer: D
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge
6) If the direct quote for a U.S. investor for British pounds is $1.43/£, then the indirect quote for
the U.S. investor would be ________ and the direct quote for the British investor would be
________.
A) £0.699/$; £0.699/$
B) $0.699/£; £0.699/$
C) £1.43/£; £0.699/$
D) £0.699/$; $1.43/£
Answer: A
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
7) ________ make money on currency exchanges by the difference between the ________ price,
or the price they offer to pay, and the ________ price, or the price at which they offer to sell the
currency.
A) Dealers; ask; bid
B) Dealers; bid; ask
C) Brokers; ask; bid
D) Brokers; bid; ask
Answer: B
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
TABLE 5.1
Use the table to answer following question(s).
8) Refer to Table 5.1. The current spot rate of dollars per pound as quoted in a newspaper is
________ or ________.
A) £1.4484/$; $0.6904/£
B) $1.4481/£; £0.6906/$
C) $1.4484/£; £0.6904/$
D) £1.4487/$; $0.6903/£
Answer: C
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
9) Refer to Table 5.1. The one-month forward bid price for dollars as denominated in Japanese
yen is:
A) -¥20.
B) -¥18.
C) ¥129.74/$.
D) ¥129.62/$.
Answer: D
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
10) Refer to Table 5.1. The ask price for the two-year swap for a British pound is:
A) $1.4250/£.
B) $1.4257/£.
C) -$230.
D) -$238.
Answer: B
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
11) Refer to Table 5.1. According to the information provided in the table, the 6-month yen is
selling at a forward ________ of approximately ________ per annum. (Use the mid rates to
make your calculations.)
A) discount; 2.09%
B) discount; 2.06%
C) premium; 2.09%
D) premium; 2.06%
Answer: C
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
12) Given the following exchange rates, which of the multiple-choice choices represents a
potentially profitable intermarket arbitrage opportunity?
¥129.87/$
1.1226/$
0.00864/¥
A) ¥115.69/
B) ¥114.96/
C) $0.8908/
D) $0.0077/¥
Answer: B
Diff: 3
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
13) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of
0.8909/ to $0.8709/. Thus, the dollar has ________ by ________.
A) appreciated; 2.30%
B) depreciated; 2.30%
C) appreciated; 2.24%
D) depreciated; 2.24%
Answer: A
Diff: 3
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
14) A German firm is attempting to determine the euro/pound exchange rate and has the
following exchange rate information: USD/pound = $1.5509/£ and the USD/euro rate =
$1.2194/. Therefore, the euro/pound rate must be:
A) £1.2719/.
B) 1.2719/£.
C) 0.7316/£.
D) 0.7863/£.
Answer: B
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Analytical
AACSB: Analytical thinking
15) The European and American terms for foreign currency exchange are square roots of one
another.
Answer: FALSE
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge
16) When the cross rate for currencies offered by two banks differs from the exchange rate
offered by a third bank, a triangular arbitrage opportunity exists.
Answer: TRUE
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge
17) A confusing "quirk" of international exchange rates occurs when calculating the percentage
change in spot rates from one period to another. The percent change in the spot rate from one
period to another when quoted using foreign currency terms is always greater than the percent
changes quoted when using home currency terms.
Answer: FALSE
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
18) The most commonly quoted currency exchange is that between the U.S. dollar and the
European euro. For example, a quotation of EUR/USD 1.2174. The euro is the base currency and
the dollar the price currency.
Answer: TRUE
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Recognition
AACSB: Application of knowledge
19) Since in the U.S. the home currency is the dollar and the foreign currency is the euro, in New
York USD 1.2174 = EUR 1.00 would be a direct quote on the euro and an indirect quote on the
dollar.
Answer: TRUE
Diff: 1
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
20) A bid is the price in one currency at which a dealer will buy another currency. An ask is the
price at which a dealer will sell the other currency. Dealers bid (buy) at one price and ask (sell) at
a slightly higher price, making their profit from the spread between the prices. List and explain
three reasons/factors that could make the spread small.
Answer: The bid-ask spread may be quite large for currencies that are traded infrequently, in
small volumes, or both. The spread in wholesale transactions between banks and large
corporations is normally smaller than in the retail market. Competition among dealers worldwide
narrows the spread between bids and offers and so contributes to making the foreign exchange
market "efficient" in the same sense as are securities markets. Other factors that affect the spread
are the cost of processing orders, the cost of maintaining an inventory of a particular currency,
and the volatility in the value of a currency.
Diff: 2
L.O.: 5.4 Foreign Exchange Rates and Quotations
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 6 International Parity Conditions
6.1 Prices and Exchange Rates
1) If an identical product can be sold in two different markets, and no restrictions exist on the
sale or transportation of product between markets, the product's price should be the same in both
markets. This is known as:
A) relative purchasing power parity.
B) interest rate parity.
C) the law of one price.
D) equilibrium.
Answer: C
Diff: 1
L.O.: 6.1 Prices and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
2) The Economist publishes annually the "Big Mac Index" by which they compare the prices of
the McDonald's Corporation's Big Mac hamburger around the world. The index estimates the
exchange rates for currencies based on the assumption that the burgers in question are the same
across the world and therefore, the price should be the same. If a Big Mac costs $2.54 in the
United States and 294 yen in Japan, what is the estimated exchange rate of yen per dollar as
hypothesized by the Hamburger index?
A) $0.0086/¥
B) ¥124/$
C) $0.0081/¥
D) ¥115.75/$
Answer: D
Diff: 3
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
3) If the current exchange rate is 113 Japanese yen per U.S. dollar, the price of a Big Mac
hamburger in the United States is $3.41, and the price of a Big Mac hamburger in Japan is 280
yen, then other things equal, the Big Mac hamburger in Japan is:
A) correctly priced.
B) under priced.
C) over priced.
D) There is not enough information to determine if the price is appropriate or not.
Answer: B
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
4) The price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0. What is the
implied PPP of the Peso per dollar?
A) Peso 8.50/$1
B) Peso 10.8/$1
C) Peso 11.76/$1
D) None of the above
Answer: A
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
5) Assume the implied PPP rate of exchange of Mexican Pesos per U.S. dollar is 8.50 according
to the Big Mac Index. Further, assume the current exchange rate is Peso 10.80/$1. Thus,
according to PPP and the Law of One Price, at the current exchange rate the peso is:
A) overvalued.
B) undervalued.
C) correctly valued.
D) There is not enough information to answer this question.
Answer: B
Diff: 3
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
6) According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but
the actual exchange rate is peso 10.80/$1. Thus, at current exchange rates the peso appears to be
________ by ________.
A) overvalued; approximately 21%
B) overvalued; approximately 27%
C) undervalued; approximately 21%
D) undervalued; approximately 27%
Answer: C
Diff: 3
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
7) Other things equal, and assuming efficient markets, if a Honda Accord costs $24,682 in the
U.S., then at an exchange rate of $1.57/£, the Honda Accord should cost ________ in Great
Britain.
A) £24,682
B) £38,751
C) £10,795
D) £15,721
Answer: D
Diff: 1
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
8) One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time
the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of
Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be
approximately:
A) $0.96/C$.
B) $1/C$.
C) $1.04/C$.
D) Relative PPP provides no guide for this type of question.
Answer: C
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
9) ________ states that differential rates of inflation between two countries tend to be offset over
time by an equal but opposite change in the spot exchange rate.
A) The Fisher Effect
B) The International Fisher Effect
C) Absolute Purchasing Power Parity
D) Relative Purchasing Power Parity
Answer: D
Diff: 1
L.O.: 6.1 Prices and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
10) Two general conclusions can be made from the empirical tests of purchasing power parity
(PPP):
A) PPP holds up well over the short run but poorly for the long run, and the theory holds better
for countries with relatively low rates of inflation.
B) PPP holds up well over the short run but poorly for the long run, and the theory holds better
for countries with relatively high rates of inflation.
C) PPP holds up well over the long run but poorly for the short run, and the theory holds better
for countries with relatively low rates of inflation.
D) PPP holds up well over the long run but poorly for the short run, and the theory holds better
for countries with relatively high rates of inflation.
Answer: D
Diff: 1
L.O.: 6.1 Prices and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
11) A country's currency that strengthened relative to another country's currency by more than
that justified by the differential in inflation is said to be ________ in terms of PPP.
A) overvalued
B) overcompensating
C) undervalued
D) undercompensating
Answer: A
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
12) If we set the real effective exchange rate index between Canada and the United States equal
to 100 in 1998, and find that the U.S. dollar has risen to a value of 112.6, then from a
competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) very competitive.
D) There is not enough information to answer this question.
Answer: A
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
13) If we set the real effective exchange rate index between the United Kingdom and the United
States equal to 100 in 2005, and find that the U.S. dollar has changed to a value of 91.4, then
from a competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) equally valued.
D) There is not enough information to answer this question.
Answer: B
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
14) The government just released international exchange rate statistics and reported that the real
effective exchange rate index for the U.S. dollar vs. the Japanese yen decreased from 105 last
year to 95 currently and is expected to fall still further in the coming year. Other things equal,
U.S. ________ to/from Japan think this is good news, and U.S. ________ to/from Japan think
this is bad news.
A) importers; exporters
B) importers; importers
C) exporters; exporters
D) exporters; importers
Answer: D
Diff: 3
L.O.: 6.1 Prices and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
15) Exchange rate pass-through may be defined as:
A) the bid/ask spread on currency exchange rate transactions.
B) the degree to which the prices of imported and exported goods change as a result of exchange
rate changes.
C) the PPP of lesser-developed countries.
D) the practice by Great Britain of maintaining the relative strength of the currencies of the
Commonwealth countries under the current floating exchange rate regime.
Answer: B
Diff: 1
L.O.: 6.1 Prices and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
16) Phillips NV produces DVD players and exports them to the United States. Last year the
exchange rate was $1.25/euro and Phillips charged 120 euro per player in Euroland and $150 per
DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is
charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD
players?
A) 92%
B) 33.3%
C) 41.7%
D) 4.1%
Answer: C
Diff: 3
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
17) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in
the UK with a 20% margin for a price of £27,363. Today these cars are available in the U.S. for
$55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has
committed to keeping the U.S. price at $55,000 for the next six months. If the UK pound
appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against
currency changes, what is the amount the company will receive in pounds at the new exchange
rate?
A) £22,803
B) £25,581
C) £27,363
D) £55,000
Answer: B
Diff: 3
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
18) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in
the UK with a 20% margin for a price of £27,363. Today these cars are available in the U.S. for
$55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has
committed to keeping the U.S. price at $55,000 for the next six months. If the UK pound
appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against
currency changes, what is the percentage margin the company will realize given the new
exchange rate?
A) 20.0%
B) 15.3%
C) 12.2%
D) 7.2%
Answer: C
Diff: 3
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
19) The price elasticity of demand for DVD players manufactured by Sony of Japan is greater
than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the
Sony DVD players in the U.S also rises by 10%, then other things equal, the total dollar sales
revenues of Sony DVDs would:
A) decline.
B) increase.
C) stay the same.
D) insufficient information
Answer: A
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
20) If a market basket of goods cost $100 in the U.S. and 70 in France, then the PPP exchange
rate would be $.70/.
Answer: FALSE
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
21) The assumptions for relative PPP are more rigid than the assumptions for absolute PPP.
Answer: FALSE
Diff: 1
L.O.: 6.1 Prices and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
22) Empirical tests prove that PPP is an accurate predictor of future exchange rates.
Answer: FALSE
Diff: 1
L.O.: 6.1 Prices and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
23) Consider the price elasticity of demand. If a product has price elasticity less than one, it is
considered to have relatively elastic demand.
Answer: FALSE
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
24) The authors state that empirical tests of purchasing power parity "have, for the most part, not
proved PPP to be accurate in predicting future exchange rates." The authors then state that PPP
does hold up reasonably well in two situations. What are some reasons why PPP does not
accurately predict future exchange rates, and under what conditions might we reasonably expect
PPP to hold?
Answer: PPP does not hold because goods and services do not move without cost between
countries and markets. Often, goods and services are nor perfect substitutes in every market for
reasons of availability, taste, quality, and production techniques. Having said that, PPP does
appear to work reasonably well over the long run and especially in countries with higher rates of
inflation and underdeveloped capital markets.
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
25) The Big Mac is considered a good candidate for the application of the law of one price and
measurement of under- or overvaluation of a currency. Develop an argument as to why this is a
good idea.
Answer: First, the product itself is nearly identical in each market. This is the result of product
consistency, process excellence, and McDonald's brand image and pride. Second, and just as
important, the product is a result of predominantly local materials and input costs. This means
that its price in each country is representative of domestic costs and prices and not imported
ones, which would be influenced by exchange rates themselves. The index, however, still
possesses limitations. Big Macs cannot be traded across borders, and costs and prices are
influenced by a variety of other factors in each country market, such as real estate rental rates
and taxes.
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
26) Explain the logic behind the application of the PPP theory to explain changes in the spot
exchange rate.
Answer: The logic behind the application of PPP to changes in the spot exchange rate is that if a
country experiences inflation rates higher than those of its main trading partners, and its
exchange rate does not change, its exports of goods and services become less competitive with
comparable products produced elsewhere. Imports from abroad become more price-competitive
with higher-priced domestic products. These price changes lead to a deficit on the current
account in the balance of payments unless offset by capital and financial flows.
Diff: 2
L.O.: 6.1 Prices and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
6.2 Interest Rates and Exchange Rates
1) ________ states that nominal interest rates in each country are equal to the required real rate
of return plus compensation for expected inflation.
A) Absolute PPP
B) Relative PPP
C) The Law of One Price
D) The Fisher Effect
Answer: D
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
2) In its approximate form the Fisher effect may be written as ________, where i = the nominal
rate of interest, r = the real rate of return and π = the expected rate of inflation.
A) i = (r)(π)
B) i = r + π + (r)(π)
C) i = r + π
D) i = r + 2π
Answer: C
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
3) Assume a nominal interest rate on one-year U.S. Treasury Bills of 2.60% and a real rate of
interest of 1.00%. Using the Fisher Effect Equation, what is the approximate expected rate of
inflation in the U.S. over the next year?
A) 2.10%
B) 2.05%
C) 1.60%
D) 1.00%
Answer: C
Diff: 2
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Application of knowledge
4) Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of
interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation
in the U.S. over the next year?
A) 1.84%
B) 1.80%
C) 1.76%
D) 1.72%
Answer: C
Diff: 3
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
5) The relationship between the percentage change in the spot exchange rate over time and the
differential between comparable interest rates in different national capital markets is known as:
A) absolute PPP.
B) the law of one price.
C) relative PPP.
D) the international Fisher Effect.
Answer: D
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
6) According to the international Fisher Effect, if an investor purchases a five-year U.S. bond
that has an annual interest rate of 5% rather than a comparable British bond that has an annual
interest rate of 6%, then the investor must be expecting the ________ to ________ at a rate of at
least 1% per year over the next 5 years.
A) British pound; appreciate
B) British pound; revalue
C) U.S. dollar; appreciate
D) U.S. dollar; depreciate
Answer: C
Diff: 2
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
7) ________ states that the spot exchange rate should change in an equal amount but in the
opposite direction to the difference in interest rates between two countries.
A) Fisher-open
B) Fisher-closed
C) The Fisher Effect
D) none of the above
Answer: A
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
8) A ________ is an exchange rate quoted today for settlement at some time in the future.
A) spot rate
B) forward rate
C) currency rate
D) yield curve
Answer: B
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
9) Assume the current U.S. dollar-British spot rate is £0.6993/$. If the current nominal one-year
interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate
forward exchange rate for 360 days?
A) £1.42/$
B) £1.43/$
C) £0.6993/$
D) £0.7060/$
Answer: D
Diff: 3
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
10) Assume the current U.S. dollar-yen spot rate is ¥90/$. Further, the current nominal 180-day
rate of return in Japan is 1% and 2% in the United States. What is the approximate forward
exchange rate for 180 days?
A) ¥89.12/$
B) ¥89.55/$
C) ¥90.89/$
D) ¥90.45/$
Answer: B
Diff: 3
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
11) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is
¥127/$ then the yen is selling at a per annum ________ of ________.
A) premium; 1.57%
B) premium; 6.30%
C) discount; 1.57%
D) discount; 6.30%
Answer: D
Diff: 3
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
12) The forward rate is calculated from all the following observable data items EXCEPT:
A) the forecast of the future spot exchange rate.
B) the home currency deposit rate.
C) the foreign currency deposit rate.
D) the spot exchange rate.
Answer: A
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
13) The theory of ________ states that the difference in the national interest rates for securities
of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or
premium for the foreign currency, except for transaction costs.
A) international Fisher Effect
B) absolute PPP
C) interest rate parity
D) the law of one price
Answer: C
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
14) With covered interest arbitrage:
A) the market must be out of equilibrium.
B) a "riskless" arbitrage opportunity exists.
C) the arbitrageur trades in both the spot and future currency exchange markets.
D) all of the above
Answer: D
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
15) Arbitragers applying Covered Interest Arbitrage drive the international currency and money
markets toward the equilibrium described by:
A) the effective exchange rate index.
B) the purchasing power parity.
C) the nominal effective exchange rate index.
D) the interest rate parity.
Answer: D
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
16) Covered interest arbitrage moves the market ________ equilibrium because ________.
A) toward; purchasing a currency on the spot market and selling in the forward market narrows
the differential between the two
B) toward; investors are now more willing to invest in risky securities
C) away from; purchasing a currency on the spot market and selling in the forward market
increases the differential between the two
D) away from; demand for the stronger currency forces up interest rates on the weaker security
Answer: A
Diff: 2
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
17) The final component of the equation for the Fisher Effect, (r)(π), where r = the real rate of
return and π = the expected rate of inflation, is often dropped from the equation because the
number is simply too large for most Western economies.
Answer: FALSE
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
18) Empirical studies show that the Fisher Effect works best for short-term securities.
Answer: TRUE
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Recognition
AACSB: Application of knowledge
19) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is
¥127/$ then the yen is at a forward premium.
Answer: FALSE
Diff: 2
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
20) The premium or discount on forward currency exchange rates between any two countries is
visually obvious when you plot the interest rates of each country on the same yield curve. The
currency of the country with the higher yield curve should be selling at a forward discount.
Answer: TRUE
Diff: 2
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
21) Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-
free one-year U.S. security with an annual return of 4%, and a comparable British security with a
return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction
costs, the investor should invest in the U.S. security.
Answer: FALSE
Diff: 2
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
22) Both covered and uncovered interest arbitrage are risky operations in the sense that even
without default in the securities, the returns are unknown until all transactions are complete.
Answer: FALSE
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
23) All that is required for a covered interest arbitrage profit is for interest rate parity to not hold.
Answer: TRUE
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
24) COVERED interest arbitrage (CIA), is where investors borrow in countries and currencies
exhibiting relatively low interest rates and convert the proceeds into currencies that offer much
higher interest rates. The transaction is "covered," because the investor does not sell the higher
yielding currency proceeds forward.
Answer: FALSE
Diff: 1
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
25) The authors describe an application of uncovered interest arbitrage (UIA) known as "yen
carry trade." Define UIA and describe the example of yen carry trade. Why would an investor
engage in the practice of yen carry trade and is there any risk of loss or lesser profit from this
investment strategy?
Answer: UIA is the practice of investors borrowing money in countries where interest rates are
relatively low, converting the loan proceeds into a currency where rates are relatively high,
investing at the higher rate, subsequently converting the proceeds back into the original currency
to repay the proceeds from the loan and hopefully realizing a greater return from this practice
than if the borrowing and investing had all taken place in the original currency. The arbitrage is
uncovered because at the time of the investment the investor does not lock in a forward exchange
rate and therefore bears the risk that currency exchange rates will change in an unfavorable
manner. The yen carry trade exists because rates in Japan are so very low that investors borrow
yen, convert to another currency, say U.S. dollars, invest at much higher interest rates, often in
default-risk free Treasury securities, then convert back to yen, repay the original loan and walk
away with a significantly greater return than otherwise available. The risk in this process is
neither from the investment nor from the loan. The risk is that exchange rates may change
unfavorably and the investor takes a loss rather than a profit.
Diff: 3
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Analytical
AACSB: Analytical thinking
26) The Fisher Effect is a familiar economic theory in the domestic market. In words, define the
Fisher Effect and explain why you think it is also appropriately applied to international markets.
Answer: Irving Fisher was an early 20th century economist who hypothesized that all market
determined nominal interest rates had at least two basic components. First, a real return is
required to compensate investors for postponing current consumption. This real rate is constant
and unaffected by expectations about inflation. Second, an expected inflation component is
required so that investors would not expect to lose purchasing power by the act of forgoing
current consumption. Intuitively, if capital can move freely among international markets these
same requirements must exist in each of the capital markets and the Fisher Effect would apply
internationally as well as domestically.
Diff: 2
L.O.: 6.2 Interest Rates and Exchange Rates
Skill: Conceptual
AACSB: Application of knowledge
6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
1) If the forward rate is an unbiased predictor of the expected spot rate, which of the following is
NOT true?
A) The expected value of the future spot rate at time 2 equals the present forward rate for time 2
delivery, available now.
B) The distribution of possible actual spot rates in the future is centered on the forward rate.
C) The future spot rate will actually be equal to what the forward rate predicts.
D) All of the above are true.
Answer: C
Diff: 2
L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT an assumption of market efficiency?
A) Instruments denominated in other currencies are perfect substitutes for one another.
B) Transaction costs are low or nonexistent.
C) All relevant information is quickly reflected in both spot and forward exchange markets.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
Skill: Recognition
AACSB: Application of knowledge
3) Empirical tests have yielded ________ evidence about market efficiency with a general
consensus that developing foreign markets are ________.
A) conflicting; not efficient
B) conflicting; efficient
C) consistent; inefficient
D) none of the above
Answer: A
Diff: 2
L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
Skill: Recognition
AACSB: Application of knowledge
4) If exchange markets were not efficient, it would pay for a firm to spend resources on
forecasting exchange rates.
Answer: TRUE
Diff: 1
L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
Skill: Conceptual
AACSB: Application of knowledge
5) If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates
will always be equal to current forward rates.
Answer: FALSE
Diff: 1
L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
Skill: Conceptual
AACSB: Application of knowledge
6) If exchange markets were efficient, the deviation of the actual future quote and today's
forward rate will be zero.
Answer: FALSE
Diff: 1
L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
Skill: Conceptual
AACSB: Application of knowledge
7) Some forecasters believe that foreign exchange markets for the major floating currencies are
"efficient" and forward exchange rates are unbiased predictors of future spot exchange rates.
Explain the rationale of this statement including the assumptions made, the meaning of
"efficient" and "unbiased," and the empirical evidence.
Answer: If the forward rate is an unbiased predictor of the future spot rate, the expected value of
the future spot rate at time 2 equals the present forward rate for time 2 delivery, available now,
E1(S2) = F1,2. Intuitively, this means that the distribution of possible actual spot rates in the
future is centered on the forward rate. The fact that it is an unbiased predictor, however, does not
mean that the future spot rate will actually be equal to what the forward rate predicts. Unbiased
prediction simply means that the forward rate will, on average, overestimate and underestimate
the actual future spot rate in equal frequency and degree. The forward rate may, in fact, never
actually equal the future spot rate.
The rationale for this relationship is based on the hypothesis that the foreign exchange market is
reasonably efficient. Market efficiency assumes that 1) All relevant information is quickly
reflected in both the spot and forward exchange markets; 2) Transaction costs are low; and
3) Instruments denominated in different currencies are perfect substitutes for one another.
Empirical studies of the efficient foreign exchange market hypothesis have yielded conflicting
results. Nevertheless, a consensus is developing that rejects the efficient market hypothesis. It
appears that the forward rate is not an unbiased predictor of the future spot rate and that it does
pay to use resources to attempt to forecast exchange rates.
Diff: 2
L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate
Skill: Conceptual
AACSB: Application of knowledge
6.4 Prices, Interest Rates, and Exchange Rates in Equilibrium
1) According to the International Fisher Effect, the forecast change in the spot rate between two
countries is equal to:
A) the current spot rate multiplied by the ratio of the inflation rates in the respective countries.
B) but the opposite sign to the difference between nominal interest rates.
C) but the opposite sign to the difference between inflation rates.
D) but the opposite sign to the difference between real interest rates.
Answer: B
Diff: 1
L.O.: 6.4 Prices, Interest Rates, and Exchange Rates in Equilibrium
Skill: Recognition
AACSB: Application of knowledge
2) In their approximate form, PPP, IRP, and forward rates as an unbiased predictor of the future
spot rate lead to similar forecasts of the future spot rate.
Answer: TRUE
Diff: 1
L.O.: 6.4 Prices, Interest Rates, and Exchange Rates in Equilibrium
Skill: Recognition
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 7 Foreign Currency Derivatives: Futures and Options
7.1 Foreign Currency Futures
1) Financial derivatives are powerful tools that can be used by management for purposes of:
A) speculation.
B) hedging.
C) human resource management.
D) A and B above
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge
2) A foreign currency ________ contract calls for the future delivery of a standard amount of
foreign exchange at a fixed time, place, and price.
A) futures
B) forward
C) option
D) swap
Answer: A
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge
3) Which of the following is NOT a contract specification for currency futures trading on an
organized exchange?
A) size of the contract
B) maturity date
C) last trading day
D) All of the above are specified.
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge
4) About ________ of all futures contracts are settled by physical delivery of foreign exchange
between buyer and seller.
A) 0%
B) 5%
C) 50%
D) 95%
Answer: B
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking
5) Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is
called a:
A) collateralized deposit.
B) marked market sum.
C) margin.
D) settlement.
Answer: C
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge
6) A speculator in the futures market wishing to lock in a price at which they could ________ a
foreign currency will ________ a futures contract.
A) buy; sell
B) sell; buy
C) buy; buy
D) none of the above
Answer: C
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge
7) A speculator that has ________ a futures contract has taken a ________ position.
A) sold; long
B) purchased; short
C) sold; short
D) purchased; sold
Answer: C
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge
8) Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency
futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency
futures market, and his expectations are correct, which of the following strategies would earn
him a profit?
A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.
Answer: A
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking
9) Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the
dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound
futures contract is for an amount of £62,500, how much money did Jack gain or lose from his
speculation with pound futures?
A) $937.50 loss
B) $937.50 gain
C) £937.50 loss
D) £937.50 gain
Answer: A
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking
10) Which of the following statements regarding currency futures contracts and forward
contracts is NOT true?
A) A futures contract is a standardized amount per currency whereas the forward contact is for
any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you
like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place between
individuals and banks with other banks via telecom linkages.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge
11) Which of the following is NOT a difference between a currency futures contract and a
forward contract?
A) The futures contract is marked to market daily, whereas the forward contract is only due to be
settled at maturity.
B) The counterparty to the futures participant is unknown with the clearinghouse stepping into
each transaction, whereas the forward contract participants are in direct contact setting the
forward specifications.
C) A single sales commission covers both the purchase and sale of a futures contract, whereas
there is no specific sales commission with a forward contract because banks earn a profit through
the bid-ask spread.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge
12) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. Jasper should ________ at ________ to profit from changing currency values.
A) buy yen; the forward rate
B) buy dollars; the forward rate
C) sell yen; the forward rate
D) There is not enough information to answer this question.
Answer: A
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge
13) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. If Jasper buys $100,000 worth of yen at today's spot price and sells within the next six
months at ¥128/$, he will earn a profit of:
A) $146.09.
B) $101,460.94.
C) $1460.94.
D) nothing; he will lose money
Answer: C
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking
14) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. If Jasper buys $100,000 worth of yen at today's spot price her potential gain is ________
and her potential loss is ________.
A) $100,000; unlimited
B) unlimited; unlimited
C) $100,000; $100,000
D) unlimited; $100,000
Answer: D
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking
15) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six
months. If Jasper's expectations are correct, then he could profit in the forward market by
________ and then ________.
A) buying yen for ¥128.00/$; selling yen at ¥128.53/$
B) buying yen for ¥128.53/$; selling yen at ¥128.00/$
C) There is not enough information to answer this question.
D) He could not profit in the forward market.
Answer: B
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking
16) Currency futures contracts have become standard fare and trade readily in the world money
centers.
Answer: TRUE
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge
17) The major difference between currency futures and forward contracts is that futures contracts
are standardized for ease of trading on an exchange market whereas forward contracts are
specialized and tailored to meet the needs of clients.
Answer: TRUE
Diff: 1
L.O.: 7.1 Foreign Currency Futures
Skill: Recognition
AACSB: Application of knowledge
18) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign
currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-
month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and
selling a forward contract than if he had invested her money in 6-month U.S. Treasury securities
at an annual rate of 2.50%.
Answer: FALSE
Diff: 3
L.O.: 7.1 Foreign Currency Futures
Skill: Analytical
AACSB: Analytical thinking
19) Why are foreign currency futures contracts more popular with individuals and banks while
foreign currency forwards are more popular with businesses?
Answer: Foreign currency futures are standardized contracts that lend themselves well to
speculation purposes but less so for hedging purposes. The standardized nature of the futures
contract makes it easy to trade futures and to make bets about general changes in the value of
currencies. Forward contracts are better for hedging in that they are tailored to meet the specific
needs of the client, typically a business, and can be quite useful in reducing exchange rate risk.
Banks are involved in the foreign currency futures market in part to offset positions that they
may have taken in the forward markets as dealers.
Diff: 2
L.O.: 7.1 Foreign Currency Futures
Skill: Conceptual
AACSB: Application of knowledge
7.2 Foreign Currency Options
1) A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given
amount of foreign exchange at a fixed price per unit for a specified period.
A) future
B) forward
C) option
D) swap
Answer: C
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
2) A foreign currency ________ option gives the holder the right to ________ a foreign
currency, whereas a foreign currency ________ option gives the holder the right to ________ an
option.
A) call, buy, put, sell
B) call, sell, put, buy
C) put, hold, call, release
D) none of the above
Answer: A
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
3) The price at which an option can be exercised is called the:
A) premium.
B) spot rate.
C) strike price.
D) commission.
Answer: C
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
4) A/An ________ option can be exercised only on its expiration date, whereas a/an ________
option can be exercised anytime between the date of writing up to and including the exercise
date.
A) American; European
B) American; British
C) Asian; American
D) European; American
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
5) A/An ________ option can be exercised only on its expiration date, whereas a/an ________
option can be exercised anytime between the date of writing up to and including the exercise
date.
A) American; European
B) American; British
C) Asian; American
D) European; American
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
6) A call option whose exercise price exceeds the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) over-the-spot.
Answer: C
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
7) A call option whose exercise price is less than the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) under-the-spot.
Answer: A
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
8) An option whose exercise price is equal to the spot rate is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) on-the-spot.
Answer: B
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
9) The main advantage(s) of over-the-counter foreign currency options over exchange traded
options is (are):
A) expiration dates tailored to the needs of the client.
B) amounts that are tailor made.
C) client desired expiration dates.
D) all of the above
Answer: D
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
10) As a general statement, it is safe to say that businesses generally use the ________ for
foreign currency option contracts, and individuals and financial institutions typically use the
________.
A) exchange markets; over-the-counter
B) over-the-counter; exchange markets
C) private; government sponsored
D) government sponsored; private
Answer: B
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
TABLE 7.1
Use the table to answer following question(s).
April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).
11) Refer to Table 7.1. What was the closing price of the British pound on April 18, 2009?
A) $1.448/£
B) £1.448/$
C) $14.48/£
D) none of the above
Answer: A
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking
12) Refer to Table 7.1. The exercise price of ________ giving the purchaser the right to sell
pounds in June has a cost per pound of ________ for a total price of ________.
A) 1460; 0.68 cents; $425.00
B) 1440; 1.06 cents; $662.50
C) 1450; 1.02 cents; $637.50
D) 1440; 1.42 cents; $887.50
Answer: B
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking
13) Refer to Table 7.1. The May call option on pounds with a strike price of 1440 means:
A) $88/£ per contract.
B) $0.88/£.
C) $0.0088/£.
D) none of the above
Answer: C
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking
14) Dash Brevenshure works for the currency trading unit of ING Bank in London. He
speculates that in the coming months the dollar will rise sharply vs. the pound. What should
Dash do to act on his speculation?
A) Buy a call on the pound.
B) Sell a call on the pound.
C) Buy a put on the pound.
D) Sell a put on the pound.
Answer: C
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
15) A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes
your profit if you choose to exercise the option before maturity?
A) ¥100/$
B) ¥105/$
C) ¥110/$
D) ¥115/$
Answer: D
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking
16) A call option on euros is written with a strike price of $1.30/euro. Which spot price
maximizes your profit if you choose to exercise the option before maturity?
A) $1.20/euro
B) $1.25/euro
C) $1.30/euro
D) $1.35/euro
Answer: D
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking
17) A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the
break-even price for the option?
A) $2.03/£
B) $2.07/£
C) $2.05/£
D) The answer depends upon if this is a long or a short call option.
Answer: B
Diff: 3
L.O.: 7.2 Foreign Currency Options
Skill: Analytical
AACSB: Analytical thinking
18) Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To
protect yourself against unexpected changes in the dollar/pound exchange rate you should:
A) buy a pound put option.
B) sell a pound put option.
C) buy a pound call option.
D) sell a pound call option.
Answer: C
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
19) The maximum gain for the purchaser of a call option contract is ________ while the
maximum loss is ________.
A) unlimited; the premium paid.
B) the premium paid; unlimited.
C) unlimited; unlimited.
D) unlimited; the value of the underlying asset.
Answer: A
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
20) The buyer of a long call option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has an unlimited maximum gain potential.
D) all of the above
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
21) Which of the following is NOT true for the writer of a call option?
A) The maximum loss is unlimited.
B) The maximum gain is unlimited.
C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.
D) All of the above are true.
Answer: B
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
22) Which of the following is NOT true for the writer of a put option?
A) The maximum loss is limited to the strike price of the underlying asset less the premium.
B) The gain or loss is equal to but of the opposite sign of the buyer of a put option.
C) The maximum gain is the amount of the premium.
D) All of the above are true.
Answer: D
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
23) The buyer (long) of a put option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has maximum gain potential limited to the difference between the strike price and the
premium paid.
D) all of the above
Answer: D
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
24) The value of a European style call option is the sum of two components:
A) the present value plus the intrinsic value.
B) the time value plus the present value.
C) the intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.
Answer: C
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
25) The writer of the option is referred to as the seller, and the buyer of the option is referred to
as the holder.
Answer: TRUE
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
26) Foreign currency options are available both over-the-counter and on organized exchanges.
Answer: TRUE
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Recognition
AACSB: Application of knowledge
27) Most option profits and losses are realized through taking actual delivery of the currency
rather than offsetting contracts.
Answer: FALSE
Diff: 1
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
28) Compare and contrast foreign currency options and futures. Identify situations when you
may prefer one vs. the other when speculating on foreign exchange.
Answer: Foreign currency futures are derivative securities that allow the holder to lock in a price
today for another currency at some point in the future. The foreign currency future contract is an
obligation on the part of the parties to fulfill the terms of the contract. Even if prices change in an
unanticipated way, the parties are obligated to fulfill the terms of the contract. The foreign
currency option contract on the other hand is a right not an obligation to purchase/sell a currency
at some point in the future at a price agreed upon today. If prices change in an unexpected
manner, the buyer of the contract is under no obligation to exercise the contract. Option contracts
are better suited to situations where price changes are anticipated, but the direction of the change
is highly uncertain.
Diff: 2
L.O.: 7.2 Foreign Currency Options
Skill: Conceptual
AACSB: Application of knowledge
7.3 Option Pricing and Valuation
1) Which of the following is NOT a factor in determining the premium price of a currency
option?
A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.
Answer: D
Diff: 1
L.O.: 7.3 Option Pricing and Valuation
Skill: Recognition
AACSB: Application of knowledge
2) The ________ of an option is the value if the option were to be exercised immediately. It is
the option's ________ value.
A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum
Answer: B
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Recognition
AACSB: Application of knowledge
3) Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call
option has:
A) a time value of $0.04.
B) a time value of $0.00.
C) an intrinsic value of $0.00.
D) an intrinsic value of -$0.04.
Answer: C
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Analytical
AACSB: Analytical thinking
4) The time value is asymmetric in value as you move away from the strike price (i.e., the time
value at two cents above the strike price is not necessarily the same as the time value two cents
below the strike price).
Answer: FALSE
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Conceptual
AACSB: Application of knowledge
5) The price of an option is always somewhat greater than its intrinsic value, since there is
always some chance that the intrinsic value will rise between the present and the expiration date.
Answer: TRUE
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Conceptual
AACSB: Application of knowledge
6) Define and explain the logic for the time value of an option. Explain the value of the time
value of an option for deep out-of-the money and deep in-the-money options.
Answer: The time value of an option exists because the price of the underlying currency, the
spot rate, can potentially move further and further into the money before the option's expiration.
Time value is the area between the total value of the option and its intrinsic value. An investor
will pay something today for an out-of-the-money option (i.e., zero intrinsic value) on the chance
that the spot rate will move far enough before maturity to move the option in-the-money.
Consequently, the price of an option is always somewhat greater than its intrinsic value, since
there is always some chance — some might say 'hope everlasting' — that the intrinsic value will
rise by the expiration date. For deep out-of-the money and deep in-the-money options the value
of the time value of an option is insignificant since the chances for the option to increase in value
are slim.
Diff: 2
L.O.: 7.3 Option Pricing and Valuation
Skill: Conceptual
AACSB: Application of knowledge
7.4 Currency Option Pricing Sensitivity
1) If the spot rate changes from $1.70/£ to $1.71/£ and there is an option with an initial premium
of $0.033/£ and a delta of 0.5, then the new option premium would be:
A) $0.043/£.
B) $0.038/£.
C) $0.005/£.
D) $1.715/£.
Answer: B
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
2) As an option moves further in-the-money, delta moves toward ________.
A) 0
B) -1
C) 1
D) large numbers
Answer: C
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
3) As an option moves further out-of-the-money, delta moves toward ________.
A) 1
B) 0
C) -1
D) large negative numbers
Answer: B
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
4) Option premiums deteriorate at a/an ________ as they approach expiration.
A) increasing rate
B) proportional
C) decreasing rate
D) less than proportional rate
Answer: A
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
5) Volatility is viewed the following ways EXCEPT:
A) historic.
B) forward-looking.
C) implied.
D) spot.
Answer: D
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
6) For a $1.50/£ call option with an initial premium of $0.033/£ and a lambda of 0.4, after an
increase in annual volatility of 1 percent point — for example from 10% to 11% — the new
option premium would be:
A) $0.036/£.
B) $0.037/£.
C) $0.004/£.
D) $1.54/£.
Answer: B
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
7) Traders who believe volatilities will fall significantly in the near-term will:
A) sell futures now.
B) buy options now.
C) sell options now.
D) buy futures now.
Answer: C
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
8) For a $1.50/£ call option with an initial premium of $0.033/£ and a rho value of 0.2, after an
increase in the U.S. dollar rate from 8% to 9% — the new ATM option premium would be:
A) $0.037/£.
B) $1.55/£.
C) $0.036/£.
D) $0.035/£.
Answer: D
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
9) For a $1.50/£ call option with an initial premium of $0.033/£ and a phi value of -0.2, after an
increase in the foreign interest (the pound sterling rate) rate from 8% to 9% — the new option
premium would be:
A) $0.035/£.
B) $1.48/£.
C) $0.031/£.
D) $0.032/£.
Answer: C
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Analytical
AACSB: Analytical thinking
10) The Delta of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: C
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
11) The Theta of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: A
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
12) The Lambda of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the spot rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: B
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
13) The Rho of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: D
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
14) The Phi of an option is defined as:
A) expected change in the option premium for a small change in time to expiration.
B) expected change in the option premium for a small change in volatility.
C) expected change in the option premium for a small change in the foreign interest rate.
D) expected change in the option premium for a small change in the domestic interest rate.
Answer: C
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
15) Which of the following statements is NOT true about currency option pricing sensitivities?
A) The higher the delta, the more likely the option will move in-the-money.
B) Premiums rise with increases in volatility.
C) Premiums are relatively insensitive during the first days.
D) Increases in domestic interest rates cause decreasing call option premiums.
Answer: D
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
16) The time value is asymmetric in value as you move away from the strike price (i.e., the time
value at two cents above the strike price is not necessarily the same as the time value two cents
below the strike price).
Answer: FALSE
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Conceptual
AACSB: Application of knowledge
17) Standard foreign currency options are priced around the forward rate.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
18) As long as the option has time remaining before expiration, the option will possess time the
time value element.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
19) If an American-style option possesses time value on any day up to expiration date, the option
holder would get more by selling it than exercising it.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
20) The value of any option that is currently in-the-money (ITM) is made up entirely of time
value.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Conceptual
AACSB: Application of knowledge
21) The sensitivity of the option premium to a small change in the spot exchange rate is called
the gamma.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
22) If the rho of the specific option is known, it is easy to determine how the option's value will
change as the spot rate changes.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
23) The higher the delta the greater the probability of the option expiring in-the-money.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
24) Option values increase with the length of time to maturity. The expected change in the option
premium from a small change in the time to expiration is termed delta.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
25) The majority of the option premium is lost in the final days prior to expiration.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
26) A trader who is buying options of longer maturities will pay more, and proportionately more,
for the longer maturity options.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
27) Option volatility is defined as the square root of the standard deviation of daily percentage
changes in the underlying exchange rate.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
28) If the exchange rate's volatility is rising, and therefore the risk of the option not being
exercised is decreasing, the option premium would be increasing.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
29) The primary problem with volatility is that it is unobservable; it is the only input into the
option pricing formula that is determined subjectively by the trader pricing the option.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
30) Historical volatility is the correct method for the calculation of the option volatility.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
31) Traders by using the historical volatility assume that the immediate future will be the same as
the recent past, and the historical volatility will equal the forward-looking volatility.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
32) A trader who is purchasing a call option on foreign currency should do so before the
domestic interest rate rises.
Answer: TRUE
Diff: 2
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
33) The expected change in the option premium from a small change in the domestic interest rate
(home currency) is term rho.
Answer: TRUE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
34) The expected change in the option premium from a small change in the foreign interest rate
(foreign currency) is termed vega.
Answer: FALSE
Diff: 1
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Recognition
AACSB: Application of knowledge
35) List and explain three "Greek" elements and their impact on a call option premium.
Answer: 1) Delta: is the expected change in the option premium for a small change in the spot
rate. The higher the delta, the more likely the option will move in-the-money. 2) Theta: is the
expected change in the option premium for a small change in time to expiration. Premiums are
relatively insensitive until the final 30 or so days. 3) Lambda: is the expected change in the
option premium for a small change in volatility. Premiums rise with increases in volatility.
4) Rho: Expected change in the option premium for a small change in the domestic interest rate.
Increases in domestic interest rates cause increasing call option premiums. 5) Phi: Expected
change in the option premium for a small change in the foreign interest rate. Increases in foreign
interest rates cause decreasing call option premiums.
Diff: 3
L.O.: 7.4 Currency Option Pricing Sensitivity
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 8 Interest Risk and Swaps
8.1 Interest Rate Foundations
1) The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
D) accounts payable.
Answer: B
Diff: 2
L.O.: 8.1 Interest Rate Foundations
Skill: Recognition
AACSB: Application of knowledge
2) Historically, interest rate movements have shown less variability and greater stability than
exchange rate movements.
Answer: TRUE
Diff: 1
L.O.: 8.1 Interest Rate Foundations
Skill: Recognition
AACSB: Application of knowledge
3) Some of the world's largest and most financially sound firms may borrow at variable rates less
than LIBOR.
Answer: TRUE
Diff: 1
L.O.: 8.1 Interest Rate Foundations
Skill: Recognition
AACSB: Application of knowledge
4) The London Interbank Offered Rate (LIBOR) is published under the auspices of the British
Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing
rate.
Answer: FALSE
Diff: 1
L.O.: 8.1 Interest Rate Foundations
Skill: Recognition
AACSB: Application of knowledge
5) Interest rate calculations differ by the number of days used in the period's calculation and in
the definition of how many days there are in a year (for financial purposes). One of the practices
is to use 260 business days in a year.
Answer: FALSE
Diff: 1
L.O.: 8.1 Interest Rate Foundations
Skill: Conceptual
AACSB: Application of knowledge
8.2 The Cost of Debt
1) ________ is the possibility that the borrower's creditworthiness is reclassified by the lender at
the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a
financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
D) Credit risk; Repricing risk
Answer: D
Diff: 2
L.O.: 8.2 The Cost of Debt
Skill: Recognition
AACSB: Application of knowledge
2) Individual borrowers – whether they be governments or companies – possess their own
individual credit rating, the market's assessment of their ability to repay debt in a timely manner.
These credit assessments influence all the following EXCEPT:
A) cost of capital.
B) access to capital.
C) credit risk premium.
D) risk-free rate.
Answer: D
Diff: 2
L.O.: 8.2 The Cost of Debt
Skill: Conceptual
AACSB: Application of knowledge
3) The basis point spreads between credit ratings dramatically rise for borrowers of credit
qualities less than BBB.
Answer: TRUE
Diff: 2
L.O.: 8.2 The Cost of Debt
Skill: Recognition
AACSB: Application of knowledge
4) Sovereign credit risk is the global financial market's assessment of the ability of a sovereign
borrower to repay USD denominated debt.
Answer: FALSE
Diff: 2
L.O.: 8.2 The Cost of Debt
Skill: Recognition
AACSB: Application of knowledge
5) For a corporate borrower, it is especially important to distinguish between credit risk and
repricing risk. Explain both types of risks.
Answer: Credit risk, sometimes termed roll-over risk, is the possibility that a borrower's
creditworthiness at the time of renewing a credit — its credit rating — is reclassified by the
lender. This can result in changing fees, changing interest rates, altered credit line commitments,
or even denial. Repricing risk is the risk of changes in interest rates charged (earned) at the time
a financial contract's rate is reset. A borrower that is renewing a credit will face current market
conditions on the base rate used for financing, a true floating-rate.
Diff: 2
L.O.: 8.2 The Cost of Debt
Skill: Conceptual
AACSB: Application of knowledge
8.3 Interest Rate Risk
Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate
borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset
annually. The current LIBOR rate is 3.50%
Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit
annually. The current one-year rate is 5%.
1) Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and
repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
Answer: D
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
2) Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and
repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
Answer: B
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
3) Refer to Instruction 8.1. Choosing strategy #3 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and
repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
Answer: C
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
4) Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?
A) Strategy #1
B) Strategy #2
C) Strategy #3
D) Strategies #1 and #2
Answer: D
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
5) Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at
worst, remain at current levels, and were very confident about the firm's credit rating for the next
10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)
A) Strategy #3
B) Strategy #2
C) Strategy #1
D) Strategy #1, #2, or #3; you are indifferent among the choices.
Answer: A
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
6) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that
your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing
money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above
Answer: B
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
7) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that
your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing
money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above
Answer: C
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
8) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer
strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
Answer: A
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Conceptual
AACSB: Analytical thinking
9) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer
strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
Answer: B
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
10) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer
strategy #3? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
Answer: C
Diff: 2
L.O.: 8.3 Interest Rate Risk
Skill: Analytical
AACSB: Analytical thinking
11) Unlike the situation with exchange rate risk, there is no uncertainty on the part of
management for shareholder preferences regarding interest rate risk. Shareholders prefer that
managers hedge interest rate risk rather than having shareholders diversify away such risk
through portfolio diversification.
Answer: FALSE
Diff: 1
L.O.: 8.3 Interest Rate Risk
Skill: Conceptual
AACSB: Application of knowledge
8.4 Interest Rate Futures and FRAs
1) An interbank-traded contract to buy or sell interest rate payments on a notional principal is
called a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above
Answer: A
Diff: 1
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Recognition
AACSB: Application of knowledge
2) A/an ________ is a contract to lock in today interest rates over a given period of time.
A) forward rate agreement
B) interest rate future
C) interest rate swap
D) none of the above
Answer: B
Diff: 1
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Recognition
AACSB: Application of knowledge
3) The financial manager of a firm has a variable rate loan outstanding. If she wishes to protect
the firm against an unfavorable increase in interest rates she could:
A) sell an interest rate futures contract of a similar maturity to the loan.
B) buy an interest rate futures contract of a similar maturity to the loan.
C) swap the adjustable rate loan for another of a different maturity.
D) none of the above
Answer: A
Diff: 2
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Conceptual
AACSB: Application of knowledge
4) If a financial manager with an interest liability on a future date were to sell Futures and
interest rates end up going up, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
Answer: A
Diff: 2
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Analytical
AACSB: Analytical thinking
5) If a financial manager with an interest liability on a future date were to sell Futures and
interest rates end up going down, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
Answer: B
Diff: 2
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Analytical
AACSB: Analytical thinking
6) If a financial manager earning interest on a future date were to buy Futures and interest rates
end up going up, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
Answer: C
Diff: 2
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Analytical
AACSB: Analytical thinking
7) If a financial manager earning interest on a future date were to buy Futures and interest rates
end up going down, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
Answer: D
Diff: 2
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Analytical
AACSB: Analytical thinking
8) Interest rate futures are relatively unpopular among financial managers because of their
relative illiquidity and their difficulty of use.
Answer: FALSE
Diff: 1
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Recognition
AACSB: Application of knowledge
9) A basis point is one-tenth of one percent.
Answer: FALSE
Diff: 1
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Recognition
AACSB: Application of knowledge
10) Your firm is faced with paying a variable rate debt obligation with the expectation that
interest rates are likely to go up. Identify two strategies using interest rate futures and interest
rate swaps that could reduce the risk to the firm.
Answer: Sell a futures position. If rates change the payoff from the futures position offsets the
gain or loss on the variable rate debt obligation. Swap a variable rate debt obligation for a fixed
futures payable contract.
Diff: 3
L.O.: 8.4 Interest Rate Futures and FRAs
Skill: Conceptual
AACSB: Application of knowledge
8.5 Interest Rate Swaps
1) An agreement to swap a fixed interest payment for a floating interest payment would be
considered a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above
Answer: C
Diff: 1
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
2) An agreement to exchange interest payments based on a fixed payment for those based on a
variable rate (or vice versa) is known as a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above
Answer: C
Diff: 1
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
3) An agreement to swap the currencies of a debt service obligation would be termed a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above
Answer: A
Diff: 1
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following would be considered an example of a currency swap?
A) exchanging a dollar interest obligation for a British pound obligation
B) exchanging a eurodollar interest obligation for a dollar obligation
C) exchanging a eurodollar interest obligation for a British pound obligation
D) All of the above are examples of a currency swap.
Answer: D
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
5) A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement
to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
Answer: B
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
6) A firm with variable-rate debt that expects interest rates to rise may engage in a swap
agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
Answer: A
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
7) The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is
to:
A) do nothing.
B) pay floating and receive fixed.
C) receive floating and pay fixed.
D) none of the above
Answer: A
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
8) Which of the following is an unlikely reason for firms to participate in the swap market?
A) To replace cash flows scheduled in an undesired currency with cash flows in a desired
currency.
B) Firms may raise capital in one currency but desire to repay it in another currency.
C) Firms desire to swap fixed and variable payment or receipt of funds.
D) All of the above are likely reasons for a firm to enter the swap market.
Answer: D
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
9) The potential exposure that any individual firm bears that the second party to any financial
contract will be unable to fulfill its obligations under the contract is called:
A) interest rate risk.
B) credit risk.
C) counterparty risk.
D) clearinghouse risk.
Answer: C
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
10) A swap agreement may involve currencies or interest rates, but never both.
Answer: FALSE
Diff: 1
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
11) One of the reasons companies use interest rate swaps is because they pursue a target debt
structure that combines maturity, currency of composition, and fixed/floating pricing.
Answer: TRUE
Diff: 1
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
12) One of the reasons companies use interest rate swaps is because they are interested in
opportunities to lower the cost of their debt.
Answer: TRUE
Diff: 1
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
13) Counterparty risk is greater for exchange-traded derivatives than for over-the-counter
derivatives.
Answer: FALSE
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
14) Swap rates are derived from the yield curves in each major currency.
Answer: TRUE
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
15) A firm entering into a currency or interest rate swap agreement holds no responsibility for
the timely servicing of its own debt obligations since that responsibility now is born by the
second party to the contract.
Answer: FALSE
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
16) The real exposure of an interest or currency swap is not the total notional principal, but the
mark-to-market values of differentials in interest or currency interest payments since the
inception of the swap agreement.
Answer: TRUE
Diff: 2
L.O.: 8.5 Interest Rate Swaps
Skill: Recognition
AACSB: Application of knowledge
17) Your firm is faced with paying a variable rate debt obligation with the expectation that
interest rates are likely to go up. Identify two strategies using interest rate futures and interest
rate swaps that could reduce the risk to the firm.
Answer: Sell a futures position. If rates change the payoff from the futures position offsets the
gain or loss on the variable rate debt obligation. Swap a variable rate debt obligation for a fixed
futures payable contract.
Diff: 3
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
18) How does counterparty risk influence a firm's decision to trade exchange-traded derivatives
rather than over-the-counter derivatives?
Answer: With exchange-traded derivatives, the exchange is the clearinghouse. Thus, firms do
not need to worry about the other party making good on its obligations and it is easier to trade
the derivative products.
Diff: 3
L.O.: 8.5 Interest Rate Swaps
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 9 Foreign Exchange Rate Determination and Intervention
9.1 Exchange Rate Determination: The Theoretical Thread
1) An important thing to remember about foreign exchange rate determination is that parity
conditions, asset approach, and balance of payments approaches are ________ theories rather
than ________ theories.
A) competing; complementary
B) competing; contemporary
C) complementary; contiguous
D) complementary; competing
Answer: D
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following did NOT contribute to the exchange rate collapse in emerging markets
in the 1990s?
A) infrastructure weaknesses
B) speculation on the part of market participants
C) the sharp reduction of cross-border foreign direct investment
D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.
Answer: D
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
3) The ________ provides a means to account for international cash flows in a standardized and
systematic manner.
A) parity conditions
B) asset approach
C) balance of payments
D) International Fisher Effect
Answer: C
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
4) The ________ approach argues that equilibrium exchange rates are achieved when the net
inflow of foreign exchange arising from current account activities is equal to the net outflow of
foreign exchange arising from financial account activities.
A) balance of payments
B) monetary
C) asset market
D) law of one price
Answer: A
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
5) The ________ approach states that the exchange rate is determined by the supply and demand
for national currency stocks, as well as the expected future levels and rates of growth of
monetary stock.
A) balance of payments
B) monetary
C) asset market
D) law of one price
Answer: B
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
6) The ________ approach argues that exchange rates are determined by the supply and demand
for a wide variety of financial assets
A) balance of payments
B) monetary
C) asset market
D) law of one price
Answer: C
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
7) The ________ approach to the determination of spot exchange rates hypothesizes that the
most important factors are the relative real interest rate and a country's outlook for economic
growth and profitability.
A) balance of payments
B) parity conditions
C) managed float
D) asset market
Answer: D
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
8) The asset market approach to forecasting assumes that whether foreigners are willing to hold
claims in monetary form depends on an extensive set of investment considerations. These
include all but which of the following choices?
A) relative real interest rates
B) capital market liquidity
C) political safety
D) All of the above are considered by investors in their decision process.
Answer: D
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
9) ________ is defined as the spread of a crisis in one country to its neighboring countries and
other countries with similar characteristics.
A) Speculation
B) Contagion
C) Capital market liquidity
D) Political science
Answer: B
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
10) Critics of the balance of payments approach to exchange rate determination point to the
emphasis on ________ of currency and capital rather than ________ of money or financial
assets.
A) flows; stocks
B) stocks; flows
C) import; export
D) export; import
Answer: A
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
11) Which of the following versions of PPP is thought to be the most relevant to possibly
explaining what drives exchange rate values?
A) The Law of One Price
B) Absolute Purchasing Power Parity
C) Relative Purchasing Power Parity
D) The International Fisher Effect
Answer: C
Diff: 2
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual
AACSB: Application of knowledge
12) It is safe to say that most determinants of the spot exchange rate are also affected by changes
in the spot rate, i.e., they are linked AND mutually determined.
Answer: TRUE
Diff: 1
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual
AACSB: Application of knowledge
13) The balance of payments approach of exchange rate theory is largely dismissed by the
academic community today, while the practitioner public still rely on different variations of the
theory for their decision making.
Answer: TRUE
Diff: 1
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
14) Technical analysis of exchange rates developed in part due to the forecasting inadequacies of
fundamental exchange rate theories.
Answer: TRUE
Diff: 1
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual
AACSB: Application of knowledge
15) The authors claim that theoretical and empirical studies appear to show that fundamentals do
apply to the long-term for foreign exchange.
Answer: TRUE
Diff: 1
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
16) The authors claim that random events, institutional frictions, and technical factors may cause
currency values to deviate significantly from their long-term fundamental path.
Answer: TRUE
Diff: 1
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
17) The asset market approach to forecasting is not applicable to emerging markets.
Answer: FALSE
Diff: 1
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
18) Most theories of technical analysis differentiate fair value from market value.
Answer: TRUE
Diff: 1
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Recognition
AACSB: Application of knowledge
19) Describe the asset market approach to exchange rate determination. How is this consistent
with economic theory of (say, security) prices in general?
Answer: The asset market approach to exchange rate determination looks at relative interest
rates and prospects for economic growth and profitability. This is consistent with the pricing of
equity securities in that the price of a share of stock should reflect expectations about the timing,
magnitude, and risk of future cash flows. In other words, expectations about what is to come is
more important to the price of an asset, including currency prices, than what has occurred in the
past.
Diff: 3
L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread
Skill: Conceptual
AACSB: Application of knowledge
9.2 Currency Market Intervention
1) ________ is the active buying and selling of the domestic currency against foreign currencies.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Federal Funding
Answer: B
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
2) ________ is the alteration of economic or financial fundamentals that are thought to be drivers
of capital to flow in and out of specific currencies.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Capital Controls
Answer: A
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
3) ________ is the restriction of access to foreign currency by government.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Capital Controls
Answer: D
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT a technique used by governments or central banks to impact
domestic currency valuation?
A) Indirect Intervention
B) Direct Intervention
C) Capital Controls
D) All of the above are techniques used to control currency valuation.
Answer: D
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
5) Which of the following is NOT a motivation for a government or central bank to manipulate
domestic currency valuation?
A) fight inflation
B) slow too rapid economic growth
C) spur too slow economic growth
D) All of the above are motivations for the government or central bank to manipulate currency
values.
Answer: D
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
6) If the goal were to decrease the value of a country's currency — to fight an appreciation of the
domestic currency in exchange for foreign currency — the central bank would:
A) buy its own currency in exchange for foreign currency.
B) follow a restrictive monetary policy.
C) drive real rates of interest up.
D) sell its own currency in exchange for foreign currency.
Answer: D
Diff: 2
L.O.: 9.2 Currency Market Intervention
Skill: Conceptual
AACSB: Application of knowledge
7) If the goal were to increase the value of a country's currency — to fight an depreciation of the
domestic currency in exchange for foreign currency — the central bank would:
A) buy its own currency in exchange for foreign currency.
B) follow a expansive monetary policy.
C) drive real rates of interest down.
D) sell its own currency in exchange for foreign currency.
Answer: A
Diff: 2
L.O.: 9.2 Currency Market Intervention
Skill: Conceptual
AACSB: Application of knowledge
8) Slow economic growth and continued unemployment problems are common reasons for
central banks to hold currency values down.
Answer: TRUE
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
9) The fall in the value of the domestic currency will sharply reduce the purchasing power of
foreign tourists in the country whose currency values are falling.
Answer: FALSE
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
10) The International Monetary Fund, as one of its basic principles (Article IV), encourages
members to pursue "currency manipulation" to gain competitive advantages over other members
as opposed to engaging in military action to achieve the same advantage.
Answer: FALSE
Diff: 2
L.O.: 9.2 Currency Market Intervention
Skill: Conceptual
AACSB: Application of knowledge
11) If a central bank wishes to "defend its currency," it might follow an expansive monetary
policy, which would drive real rates of interest up.
Answer: FALSE
Diff: 2
L.O.: 9.2 Currency Market Intervention
Skill: Conceptual
AACSB: Application of knowledge
12) A country wishing for its currency to fall in value, particularly when confronted with a
continual appreciation of its value against major trading partner currencies, the central bank may
work to lower real interest rates, reducing the returns to capital.
Answer: TRUE
Diff: 2
L.O.: 9.2 Currency Market Intervention
Skill: Conceptual
AACSB: Application of knowledge
13) Indirect intervention for domestic currency valuation typically uses tools of monetary policy
as opposed to using tools of fiscal policy.
Answer: TRUE
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
14) Direct intervention for currency valuation involves limiting the ability to exchange domestic
currency for foreign currency.
Answer: FALSE
Diff: 1
L.O.: 9.2 Currency Market Intervention
Skill: Recognition
AACSB: Application of knowledge
15) Explain how a central bank would engage in direct intervention to decrease the value of its
domestic currency. Since the 1970s, it has been difficult for central banks alone to engage in
direct intervention to alter the value of their domestic currency. Identify and explain at least two
other activities in which a central bank could engage to alter the value of their domestic
currency.
Answer: To decrease the value of its domestic currency, a central bank could choose to sell its
own currency, thus making more of its currency available and driving down its value. Because
markets have become so large, it is difficult to effectively move the market in this manner.
Alternative strategies may be to enlist other central banks to make a coordinated effort to sell the
currency into the market, thus putting more currency into play and having a greater negative
impact on its value. Indirect intervention to drive down real interest rates is a second alternative,
and the reduction of capital controls may be able to render a currency less valuable as well.
Diff: 3
L.O.: 9.2 Currency Market Intervention
Skill: Conceptual
AACSB: Application of knowledge
9.3 Disequilibrium: Exchange Rates in Emerging Markets
1) Which of the following was NOT an international currency crisis in the 1990s and early
2000s?
A) the Asian Crisis
B) the Canadian Crisis
C) the Argentine Crisis
D) All of the above were currency crises in the 1990s and 2000s.
Answer: B
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
2) The Asian Currency crisis appeared to begin in:
A) South Korea.
B) Taiwan.
C) Thailand.
D) Japan.
Answer: C
Diff: 2
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
3) The "tequila effect" is a slang term used to describe a form of financial panic called:
A) run on the market.
B) speculation.
C) contrary investing.
D) contagion.
Answer: D
Diff: 2
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
4) Prior to July 2, 1997, the Thai government:
A) allowed the Thai Bhat to float against major currencies.
B) fixed the Bhat's value against the Korean won only.
C) fixed the Bhat's value against major currencies especially the U.S. dollar.
D) none of the above
Answer: C
Diff: 2
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
5) The authors did NOT identify which of the following as a root of the Asian currency crisis?
A) the collapse of some Asian currencies
B) the rate of inflation in the United States
C) corporate socialism
D) banking stability and management
Answer: B
Diff: 3
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Conceptual
AACSB: Application of knowledge
6) The authors refer to the practice of many Asian firms being largely controlled by families of
groups related to the governing body of the country as:
A) illegal.
B) insider trading.
C) cronyism.
D) not in my back yard.
Answer: C
Diff: 2
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
7) The principle focus of the IMF bailout efforts during the Asian financial crisis was:
A) banking liquidity.
B) shareholder's wealth.
C) reestablishing fixed currency exchange rates in Asia.
D) dollarization of Asian currencies.
Answer: A
Diff: 3
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
8) The ________ is the Argentine currency unit.
A) peso
B) dollar
C) real
D) peseta
Answer: A
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
9) A currency board is:
A) a structure, rather than a mere commitment, to limiting the growth of the money supply in the
economy.
B) a recipe for conservative and prudent financial management.
C) designed to eliminate the power of politicians to exercise judgment by relying on an
automatic and unbendable rule.
D) all of the above
Answer: D
Diff: 3
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
10) Argentina's economic performance in the 1990s while their peso was pegged to the U.S.
dollar can be characterized as ________ rates of inflation and ________ rates of unemployment.
A) high; high
B) low; low
C) low; high
D) high; low
Answer: C
Diff: 2
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Conceptual
AACSB: Application of knowledge
11) By 2001, crisis conditions had revealed three very important underlying problems
Argentina's economy EXCEPT:
A) The Argentine peso was overvalued.
B) The currency board regime had eliminated monetary policy alternatives for macroeconomic
policy.
C) The printing of paper money without restrictions, resulting in hyperinflation.
D) The Argentina government budget deficit was out of control - government spending
continued to increased but tax receipts did not.
Answer: C
Diff: 2
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Conceptual
AACSB: Application of knowledge
12) Which of the following did NOT contribute to the Russian currency crisis of 1998?
A) an accelerated flight of capital
B) generally deteriorating economic conditions
C) a surprisingly healthy government surplus that was neither funding internal investment nor
external debt service
D) all of the above
Answer: D
Diff: 2
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
13) In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis.
Answer: TRUE
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
14) Leading up to the Russian currency collapse of 1998, Russia followed a currency policy of
managed float that allowed their currency to slide daily at a 1.5% per month rate.
Answer: TRUE
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
15) The large and liquid capital and currency markets follow many of the principles outlined by
the different schools of thought on exchange rate determination (parity conditions, balance of
payments approach, and asset approach) relatively well in the medium to long term.
Answer: TRUE
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
16) The smaller and less liquid markets and currency markets frequently demonstrate behaviors
that follow the principles outlined by the different schools of thought on exchange rate
determination (parity conditions, balance of payments approach, and asset approach) relatively
well in the medium to long term.
Answer: FALSE
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
17) The roots of the Asian currency crisis extended from a fundamental change in the economics
of the region, the transition of many Asian nations from being net importers to net exporters.
Answer: FALSE
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
18) The most visible roots of the crisis were in the excesses of capital inflows into Thailand
extending credit to a variety of domestic investments and enterprises beyond what the Thai
economy could support and creating an investment "bubble."
Answer: TRUE
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
19) As economic conditions continued to deteriorate in Argentina by the end of 2001, banks
suffered increasing runs. The government, fearing that the increasing financial drain on banks
would cause their collapse, closed the banks for weeks.
Answer: TRUE
Diff: 1
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Recognition
AACSB: Application of knowledge
20) In 1991, Argentina adopted a currency board (the Argentine peso had been pegged to the
U.S. dollar at a one-to-one rate of exchange) to fight hyperinflation. This currency board lasted
for a decade until the economic crisis of 2001. Discuss: 1) the pros and cons of a currency board
policy, 2) the crisis condition of the Argentina's economy by 2001, and 3) the lessons to be
drawn from the Argentina story.
Answer: Under a currency board, the central bank may increase the money supply in the
banking system only with increases in its holdings of hard currency reserves. By removing the
ability of government to expand the rate of growth of the money supply, Argentina believed it
was eliminating the source of inflation that had devastated its standard of living. It was both a
recipe for conservative and prudent financial management, and a decision to eliminate the power
of politicians, elected and unelected, to exercise judgment both good and bad. It was an
automatic and unbendable rule.
This "cure" was a restrictive monetary policy that slowed economic growth. The country's
unemployment rate rose to double-digit levels in 1994 and stayed there. The real GDP growth
rate settled into recession in late 1998, and the economy continued to shrink through 2000.
Argentine banks allowed depositors to hold their money in either pesos or dollars. This was
intended to provide a market-based discipline to the banking and political systems, and to
demonstrate the government's unwavering commitment to maintaining the peso's value parity
with the dollar. Although intended to build confidence in the system, in the end it proved
disastrous to the Argentine banking system. The 1998 recession proved to be unending. Three-
and-a-half years later, Argentina was still in recession. By 2001, crisis conditions had revealed
three very important underlying problems with Argentina's economy: 1) The Argentine peso was
overvalued; 2) The currency board regime had eliminated monetary policy alternatives for
macroeconomic policy; and 3) The Argentine government budget deficit was out of control.
Inflation had not been eliminated, and the world's markets were watching.
As the unemployment rate grew higher, as poverty and social unrest grew government was faced
with pressure to close the economic and social gaps. Government spending continued to
increase, but tax receipts did not. Argentina turned to the international markets to aid in the
financing of its government's deficit spending. The total foreign debt of the country began rising
dramatically. As economic conditions continued to deteriorate, banks suffered increasing runs.
The government, fearing that the increasing financial drain on banks would cause their collapse,
closed the banks.
On Sunday, January 6, 2002 the peso was devalued from 1.00 Argentine peso per U.S. dollar to
1.40. But the economic pain continued. On February 3, 2002, the Argentine government
announced that the peso would be floated and the government would no longer attempt to fix or
manage its value to any specific level, allowing the market to find or set the exchange rate.
Diff: 3
L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets
Skill: Conceptual
AACSB: Application of knowledge
9.4 Currency Forecasting in Practice
1) ________, traditionally referred to as chartists, focus on price and volume data to determine
past trends that are expected to continue into the future.
A) Mappists
B) Trappist monks
C) Filibusters
D) Technical analysts
Answer: D
Diff: 2
L.O.: 9.4 Currency Forecasting in Practice
Skill: Recognition
AACSB: Application of knowledge
2) Examples of a business motivation for long-run exchange rate forecasts include all but which
of the following?
A) a major capital investment in a foreign country
B) the desire to hedge a 90-day security
C) a portfolio manager considering investing in foreign securities
D) All of the above are examples of a business motivation for long-run exchange rate forecast.
Answer: B
Diff: 3
L.O.: 9.4 Currency Forecasting in Practice
Skill: Recognition
AACSB: Application of knowledge
3) Short-term foreign exchange forecasts are often motivated by such activities as ________
whereas long-term forecasts are more likely motivated by ________.
A) long-term investment; long-term capital appreciation
B) long-term capital appreciation; desire to hedge a receivable
C) the desire to hedge a payable; the desire for long-term investment
D) the desire for long-term investment; the desire to hedge a payable
Answer: C
Diff: 3
L.O.: 9.4 Currency Forecasting in Practice
Skill: Recognition
AACSB: Application of knowledge
4) A major U.S. multinational firm has forecast the euro/dollar rate to be 1.10/$ one year hence,
and an exchange rate of $1.40 for the British pound (£) in the same time period. What does this
imply the company's expected rate for the euro per pound to be in one year?
A) 1.40/£
B) £1.40/
C) £1.54/
D) 1.54/£
Answer: D
Diff: 3
L.O.: 9.4 Currency Forecasting in Practice
Skill: Analytical
AACSB: Analytical thinking
5) The longer the time horizon of the technical analyst the more accurate the prediction of
foreign exchange rates is likely to be.
Answer: FALSE
Diff: 1
L.O.: 9.4 Currency Forecasting in Practice
Skill: Conceptual
AACSB: Application of knowledge
6) The single most important element of technical analysis is that future exchange rates are based
on the current exchange rate.
Answer: TRUE
Diff: 2
L.O.: 9.4 Currency Forecasting in Practice
Skill: Recognition
AACSB: Application of knowledge
7) The more efficient the foreign exchange market is, the more likely it is that exchange rate
movements are random walks.
Answer: TRUE
Diff: 1
L.O.: 9.4 Currency Forecasting in Practice
Skill: Conceptual
AACSB: Application of knowledge
8) Technical analysts, traditionally referred to as chartists, focus on fundamental data to
determine past trends that are expected to continue into the future.
Answer: FALSE
Diff: 2
L.O.: 9.4 Currency Forecasting in Practice
Skill: Conceptual
AACSB: Application of knowledge
9) Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and
contrast the motivation for and the techniques a forecaster might use for each of the time periods.
Answer: Short-run forecasts are usually more tactical in nature as a firm may desire to reduce
exchange rate risk associated with foreign receivable or payables. Technical factors and short-
term market expectations are often more important for short-run forecasters than long-run parity
or fundamental economic conditions.
Long-run forecasts are more strategic in nature as firms make key decisions about entering new
foreign markets. Longer time horizons tend to be less accurate but also require less accuracy.
What forecasters typically desire is a general long-run understanding of the relationships
between markets. Fundamental analysis and parity conditions tend to be more important than
technical factors in this type of forecasting.
Diff: 3
L.O.: 9.4 Currency Forecasting in Practice
Skill: Analytical
AACSB: Analytical thinking
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 10 Transaction Exposure
10.1 Types of Foreign Exchange Exposure
1) ________ exposure deals with cash flows that result from existing contractual obligations.
A) Operating
B) Transaction
C) Translation
D) Economic
Answer: B
Diff: 2
L.O.: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
AACSB: Application of knowledge
2) ________ exposure measures the change in the present value of the firm resulting from
unexpected changes in exchange rates.
A) Operating
B) Transaction
C) Translation
D) Accounting
Answer: A
Diff: 2
L.O.: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
AACSB: Application of knowledge
3) Each of the following is another name for operating exposure EXCEPT:
A) economic exposure.
B) strategic exposure.
C) accounting exposure.
D) competitive exposure.
Answer: C
Diff: 2
L.O.: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
AACSB: Application of knowledge
4) Transaction exposure and operating exposure exist because of unexpected changes in future
cash flows. The difference between the two is that ________ exposure deals with cash flows
already contracted for, while ________ exposure deals with future cash flows that might change
because of changes in exchange rates.
A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above
Answer: A
Diff: 2
L.O.: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
AACSB: Application of knowledge
5) ________ exposure is the potential for accounting-derived changes in owner's equity to occur
because of the need to translate foreign currency financial statements into a single reporting
currency.
A) Transaction
B) Operating
C) Economic
D) Accounting (aka translation)
Answer: D
Diff: 2
L.O.: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
AACSB: Application of knowledge
6) Losses from ________ exposure generally reduce taxable income in the year they are realized.
________ exposure losses may reduce taxes over a series of years.
A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting
Answer: C
Diff: 2
L.O.: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
AACSB: Application of knowledge
7) Losses from ________ exposure generally reduce taxable income in the year they are realized.
________ exposure losses are not cash losses and therefore, are not tax deductible.
A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation
Answer: D
Diff: 2
L.O.: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
AACSB: Application of knowledge
10.2 Why Hedge?
1) MNE cash flows may be sensitive to changes in which of the following?
A) exchange rates
B) interest rates
C) commodity prices
D) all of the above
Answer: D
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Recognition
AACSB: Application of knowledge
2) Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should
________ the variability of expected cash flows to a firm and at the same time, the expected
value of the cash flows should ________.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change
Answer: B
Diff: 2
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
3) Which of the following is NOT cited as a good reason for hedging currency exposures?
A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required
cash flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.
Answer: C
Diff: 2
L.O.: 10.2 Why Hedge?
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is cited as a good reason for NOT hedging currency exposures?
A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.
Answer: D
Diff: 2
L.O.: 10.2 Why Hedge?
Skill: Recognition
AACSB: Application of knowledge
5) A ________ hedge refers to an offsetting operating cash flow such as a payable arising from
the conduct of business.
A) financial
B) natural
C) contractual
D) futures
Answer: B
Diff: 2
L.O.: 10.2 Why Hedge?
Skill: Recognition
AACSB: Application of knowledge
6) As a generalized rule, only realized foreign exchange losses are deductible for tax purposes.
Answer: TRUE
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Recognition
AACSB: Application of knowledge
7) Many MNE s manage foreign exchange exposure centrally, thus gains or losses are always
matched with the country of origin.
Answer: FALSE
Diff: 2
L.O.: 10.2 Why Hedge?
Skill: Recognition
AACSB: Application of knowledge
8) Hedging, or reducing risk, is the same as adding value or return to the firm.
Answer: FALSE
Diff: 2
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
9) There is considerable question among investors and managers about whether hedging is a
good and necessary tool.
Answer: TRUE
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Recognition
AACSB: Application of knowledge
10) The key arguments in opposition to currency hedging such as market efficiency, agency
theory, and diversification do not have financial theory at their core.
Answer: FALSE
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
11) Management often conducts hedging activities that benefit management at the expense of the
shareholders. The field of finance called agency theory frequently argues that management is
generally LESS risk averse than are shareholders.
Answer: FALSE
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
12) Managers CAN outguess the market. If and when markets are in equilibrium with respect to
parity conditions, the expected net present value of hedging should be POSITIVE.
Answer: FALSE
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
13) Shareholders are LESS capable of diversifying currency risk than is the management of the
firm.
Answer: FALSE
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
14) Hedging can be advantageous to shareholders because management is in a better position
than shareholders to recognize disequilibrium conditions and to take advantage of single
opportunities to enhance firm value through selective hedging.
Answer: TRUE
Diff: 1
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
15) Does foreign currency exchange hedging both reduce risk and increase expected value?
Explain, and list several arguments in favor of currency risk management and several against.
Answer: Foreign exchange currency hedging can reduce the variability of foreign currency
receivables or payables by locking in a specific exchange rate in the future via a forward
contract, converting currency at the current spot rate using a money market hedge, or minimizing
unfavorable exchange rate movement with a currency option. None of these hedging techniques,
however, increases the expected value of the foreign currency exchange. In fact, expected value
should fall by an amount equal to the cost of the hedge.
Generally, those in favor of currency risk management find value in the reduction of variability
of uncertain cash flows. Those opposed to currency risk management argue the NPV of such
activities are $0 or less and that shareholders can reduce risk themselves more efficiently. For a
more complete answer to this question, see page 4 where the author outlines several arguments
for and against currency risk management.
Diff: 3
L.O.: 10.2 Why Hedge?
Skill: Conceptual
AACSB: Application of knowledge
10.3 Transaction Exposure
1) The stages in the life of a transaction exposure can be broken into three distinct time periods.
The first time period is the time between quoting a price and reaching an actual sale agreement
or contract. The next time period is the time lag between taking an order and actually filling or
delivering it. Finally, the time it takes to get paid after delivering the product. In order, these
stages of transaction exposure may be identified as:
A) backlog, quotation, and billing exposure.
B) billing, backlog, and quotation exposure.
C) quotation, backlog, and billing exposure.
D) quotation, billing, and backlog exposure.
Answer: C
Diff: 2
L.O.: 10.3 Transaction Exposure
Skill: Recognition
AACSB: Application of knowledge
2) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange
rate is $1.55/£, the account is payable in three months, and the firm chooses to avoid any hedging
techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S.
firm is at risk today of a loss if:
A) the exchange rate changes to $1.52/£.
B) the exchange rate changes to $1.58/£.
C) the exchange rate doesn't change.
D) all of the above
Answer: D
Diff: 3
L.O.: 10.3 Transaction Exposure
Skill: Analytical
AACSB: Application of knowledge
3) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange
rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any
hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If
the exchange rate changes to $1.58/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500
Answer: B
Diff: 3
L.O.: 10.3 Transaction Exposure
Skill: Analytical
AACSB: Analytical thinking
4) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange
rate is $1.55/£, the account is payable in three months, and the firm chooses to avoid any hedging
techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the
exchange rate changes to $1.52/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500
Answer: A
Diff: 3
L.O.: 10.3 Transaction Exposure
Skill: Analytical
AACSB: Analytical thinking
5) TRANSACTION exposure measures gains or losses that arise from the settlement of existing
financial obligations whose terms are stated in a foreign currency.
Answer: TRUE
Diff: 1
L.O.: 10.3 Transaction Exposure
Skill: Recognition
AACSB: Application of knowledge
6) Transaction exposure could arise when borrowing or lending funds when repayment is to be
made in the firm's domestic currency.
Answer: FALSE
Diff: 1
L.O.: 10.3 Transaction Exposure
Skill: Recognition
AACSB: Application of knowledge
10.4 Transaction Exposure Management
1) ________ is NOT a commonly used contractual hedge against foreign exchange transaction
exposure.
A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.
Answer: D
Diff: 2
L.O.: 10.4 Transaction Exposure Management
Skill: Recognition
AACSB: Application of knowledge
Instruction 10.1:
Use the information for the following problem(s).
Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a
manufacturer in Germany for 3,000,000. The purchase was made in June with payment due six
months later in December. Because this is a sizable contract for the firm and because the contract
is in euros rather than dollars, CVT is considering several hedging alternatives to reduce the
exchange rate risk arising from the sale. To help the firm make a hedging decision you have
gathered the following information.
The spot exchange rate is $1.250/euro
The six-month forward rate is $1.22/euro
CVT's cost of capital is 11%
The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
The U.S. 6-month lending rate is 6% (or 3% for 6 months)
December call options for euro 750,000; strike price $1.28, premium price is 1.5%
CVT's forecast for 6-month spot rates is $1.27/euro
The budget rate, or the highest acceptable purchase price for this project, is $3,900,000 or
$1.30/euro
2) Refer to Instruction 10.1. If CVT chooses NOT to hedge their euro payable, the amount they
pay in six months will be:
A) $3,500,000.
B) $3,900,000.
C) 3,000,000.
D) unknown today
Answer: D
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
3) Refer to Instruction 10.1. If CVT chooses to hedge its transaction exposure in the forward
market, it will ________ 3,000,000 forward at a rate of ________.
A) buy; $1.22
B) buy; $1.25
C) sell; $1.22
D) sell; 1.25
Answer: A
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
4) Refer to Instruction 10.1. CVT chooses to hedge its transaction exposure in the forward
market at the available forward rate. The required amount in dollars to pay off the accounts
payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000.
Answer: B
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
5) Refer to Instruction 10.1. If CVT locks in the forward hedge at $1.22/euro, and the spot rate
when the transaction was recorded on the books was $1.25/euro, this will result in a "foreign
exchange accounting transaction ________ of ________.
A) loss; $90,000
B) loss; 90,000
C) gain; $90,000
D) gain; 90,000
Answer: C
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
6) Refer to Instruction 10.1. CVT would be ________ by an amount equal to ________ with a
forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had
been correct.
A) better off; $150,000
B) better off; 150,000
C) worse off; $150,000
D) worse off; 150,000
Answer: A
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
7) Refer to Instruction 10.1. What is the cost of a call option hedge for CVT's euro receivable
contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as
the appropriate interest rate for calculating future values.)
A) $57,600
B) $59,904
C) $62,208
D) $63,936
Answer: B
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
8) Refer to Instruction 10.1. The cost of a put option to CVT would be:
A) $52,500.
B) $55,388.
C) $58,275.
D) There is not enough information to answer this question.
Answer: D
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
9) When attempting to manage an account payable denominated in a foreign currency, the firm's
only choice is to remain unhedged.
Answer: FALSE
Diff: 1
L.O.: 10.4 Transaction Exposure Management
Skill: Recognition
AACSB: Application of knowledge
10) Remaining unhedged is NOT an option when dealing with foreign exchange transaction
exposure.
Answer: FALSE
Diff: 1
L.O.: 10.4 Transaction Exposure Management
Skill: Recognition
AACSB: Application of knowledge
11) A forward hedge involves a put or call option contract and a source of funds to fulfill that
contract.
Answer: FALSE
Diff: 1
L.O.: 10.4 Transaction Exposure Management
Skill: Recognition
AACSB: Application of knowledge
12) Like a forward market hedge, a money market hedge also involves a contract and a source of
funds to fulfill that contract. In this instance, the contract is a loan agreement.
Answer: TRUE
Diff: 1
L.O.: 10.4 Transaction Exposure Management
Skill: Recognition
AACSB: Application of knowledge
13) Hedging transaction exposure with option contracts allows the firm to benefit if exchange
rates are favorable but protects the firm if exchange rates turn unfavorable.
Answer: TRUE
Diff: 1
L.O.: 10.4 Transaction Exposure Management
Skill: Recognition
AACSB: Application of knowledge
14) A firm's risk tolerance is a combination of management's philosophy toward transaction
exposure and the specific goals of treasury activities.
Answer: TRUE
Diff: 1
L.O.: 10.4 Transaction Exposure Management
Skill: Recognition
AACSB: Application of knowledge
15) The structure of a money market hedge is similar to a forward hedge. The difference is the
cost of the money market hedge is determined by the differential interest rates, while the forward
hedge is a function of the forward rates quotation.
Answer: TRUE
Diff: 2
L.O.: 10.4 Transaction Exposure Management
Skill: Conceptual
AACSB: Application of knowledge
16) In efficient markets, interest rate parity should assure that the costs of a forward hedge and
money market hedge should be approximately the same.
Answer: TRUE
Diff: 1
L.O.: 10.4 Transaction Exposure Management
Skill: Conceptual
AACSB: Application of knowledge
17) Currency risk management techniques include forward hedges, money market hedges, and
option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for
a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put
option strike price, and show the possible results for a money market hedge, a forward hedge, a
put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is
British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the
forward rate is $1.52/£ and the current spot rate is $1.48/£.)
Answer: The student should draw and label a diagram that looks similar to the one found in
Exhibit 10.5.
Diff: 3
L.O.: 10.4 Transaction Exposure Management
Skill: Analytical
AACSB: Analytical thinking
10.5 Transaction Exposure Management in Practice
1) ________ are transactions for which there are, at present, no contracts or agreements between
parties.
A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) none of the above
Answer: C
Diff: 2
L.O.: 10.5 Transaction Exposure Management in Practice
Skill: Recognition
AACSB: Application of knowledge
2) According to a survey by Bank of America, the type of foreign exchange risk most often
hedged by firms is:
A) translation exposure.
B) transaction exposure.
C) contingent exposure.
D) economic exposure.
Answer: B
Diff: 2
L.O.: 10.5 Transaction Exposure Management in Practice
Skill: Recognition
AACSB: Application of knowledge
3) The treasury function of most firms, the group typically responsible for transaction exposure
management, is NOT usually considered a profit center.
Answer: TRUE
Diff: 1
L.O.: 10.5 Transaction Exposure Management in Practice
Skill: Recognition
AACSB: Application of knowledge
4) According to the authors, firms that employ proportional hedges increase the percentage of
forward-cover as the maturity of the exposure lengthens.
Answer: FALSE
Diff: 1
L.O.: 10.5 Transaction Exposure Management in Practice
Skill: Recognition
AACSB: Application of knowledge
5) Although rarely acknowledged by the firms themselves, selective hedging is essentially
speculation.
Answer: TRUE
Diff: 1
L.O.: 10.5 Transaction Exposure Management in Practice
Skill: Recognition
AACSB: Application of knowledge
6) There are as many different approaches to foreign exchange transaction exposure management
as there are firms and no real consensus exists regarding the best approach. List and discuss three
different exposures you can hedge and three different types of hedges (for example option
hedges versus non-option hedges).
Answer: Foreign exchange exposure is a measure of the potential for a firm's profitability, net
cash flow, and market value to change because of a change in exchange rates. There are two
distinct categories of foreign exchange exposure for the firm: 1) Accounting exposure
(transaction exposure and translation exposure) arises from contracts and accounts being
denominated in foreign currency, 2) Economic exposure is the potential change in the value of
the firm from its changing global competitiveness as determined by exchange rates.
A transaction exposure is created at the first moment the seller quotes a price in foreign currency
terms to a potential buyer (quotation exposure). When the order is placed, the potential exposure
created at the time of the quotation is converted into actual exposure, called backlog exposure,
because the product has not yet been shipped or billed. Backlog exposure lasts until the goods
are shipped and billed, at which time it becomes billing exposure. Billing exposure remains until
payment is received by the seller.
Transaction exposure management programs are generally divided along an "option-line," those
that use options (calls and puts) and those that do not (forward/futures contracts and money
market hedges).
Diff: 2
L.O.: 10.5 Transaction Exposure Management in Practice
Skill: Conceptual
AACSB: Application of knowledge
7) Many MNEs have established rigid transaction exposure risk management policies which
mandate proportional hedging (a percentage of existing transaction exposures). Explain the pros
and cons of proportional hedging.
Answer: First of all, hedging is expensive. These policies generally require the use of forward
contract hedges on a percentage (e.g., 50, 60, or 70%) of existing transaction exposures. As the
maturity of the exposures lengthens, the percentage forward-cover required decreases. The
remaining portion of the exposure is then selectively hedged on the basis of the firm's risk
tolerance, view of exchange rate movements, and confidence level. Although rarely
acknowledged by the firms themselves, selective hedging is essentially speculation. A significant
question remains as to whether a firm or a financial manager can consistently predict the future
direction of exchange rates.
Diff: 2
L.O.: 10.5 Transaction Exposure Management in Practice
Skill: Conceptual
AACSB: Application of knowledge
Appendix B — The Optimal Hedge Ratio and Hedge Effectiveness
1) When there is a full forward cover with the spot rate equal to the forward rate all of the
following are true EXCEPT:
A) The hedge is asymmetric.
B) There is no uncovered exposure remaining.
C) The total position is a perfect hedge.
D) The currency hedge ratio is equal to 1.
Answer: A
Diff: 3
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
2) The objective of currency hedging is to eliminate the change in the value of the exposed asset
or cash flow from a change in exchange rates.
Answer: FALSE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
3) Hedging is accomplished by combining the exposed asset with a hedge asset to create a two-
asset portfolio in which the two assets react in relatively equal directions to an exchange rate
change.
Answer: FALSE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
4) With the use of forwards, a perfect hedge is possible.
Answer: TRUE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
5) With a perfect hedge, there is no uncovered exposure remaining.
Answer: TRUE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
6) A hedge constructed using puts foreign currency options would be symmetric.
Answer: FALSE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
7) The commonly used 100% forward contract cover is a symmetric hedge.
Answer: TRUE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
8) The effectiveness of a hedge is determined to what degree the change in spot asset's value is
correlated with the equal change in the hedge asset's value to a change in the underlying spot
exchange rate.
Answer: FALSE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
9) The hedge ratio, β, is an individual exposure's nominal amount covered by a financial
instrument such as a forward contract or currency option.
Answer: FALSE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
10) A hedge constructed using a put foreign currency option would protect you against value
losses, but allow, at the same time, the possibly reap value increases in the event the exchange
rate moved in your favor.
Answer: TRUE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
11) The various hedging alternatives explored (the forward, money market, and purchase option
hedges) only work to protect the value of the exposed asset at the time of maturity.
Answer: FALSE
Diff: 1
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
12) There are as many different approaches to exposure management as there are firms and no
real consensus exists regarding the best approach. Discuss the following theoretical dimensions
to currency hedging: optimal hedge ratio, hedge symmetry, hedge effectiveness and hedge
timing.
Answer: The objective of currency hedging is to minimize the change in the value of the
exposed asset or cash flow from a change in exchange rates. Hedging is accomplished by
combining the exposed asset with a hedge asset to create a two-asset portfolio in which the two
assets react in relatively equal but opposite directions to an exchange rate change. If the entire
exposure was covered, that is a hedge ratio of 1.0 or 100%. The hedge ratio, β, is the percentage
of an individual exposure's nominal amount covered by a financial instrument such as a forward
contract or currency option.
Some hedges can be constructed to result in no change in value to any and all exchange rate
changes. The hedge is constructed so that whatever spot value is lost (or gained) as a result of
aderse (or faorale) exchane rate moements ( pot), that alue is replaced  an equal ut
opposite chane in the alue of the hede asset, ( ede). The 1 forward contract cover is
symmetrical hedge.
The effectiveness of a hedge is determined to what degree the change in spot asset's value is
correlated with the equal but opposite change in the hedge asset's value to a change in the
underlying spot exchange rate. The less than perfect correlation is termed basis risk.
The hedger must also determine the timing of the hedge objective. The hedger can protect the
value of the exposed asset only at the time of its maturity or settlement, or at various points in
time over the life of the exposure.
Diff: 2
L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 11 Translation Exposure
11.1 Overview of Translation
1) Translation exposure may also be called ________ exposure.
A) transaction
B) operating
C) accounting
D) currency
Answer: C
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
2) ________ exposure is the potential for an increase or decrease in the parent company's net
worth and reported net income caused by a change in exchange rates since the last transaction.
A) Transaction
B) Operating
C) Currency
D) Translation
Answer: D
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
3) Translation exposure measures:
A) changes in the value of outstanding financial obligations incurred prior to a change in
exchange rates.
B) the potential for an increase or decrease in the parent company's net worth and reported net
income caused by a change in exchange rates since the last consolidation of international
operations.
C) an unexpected change in exchange rates impact on short run expected cash flows.
D) none of the above
Answer: B
Diff: 2
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
4) According to your authors, the main purpose of translation is:
A) to prepare consolidated financial statements.
B) to help management assess the performance of foreign subsidiaries.
C) to act as an interpreter for managers without foreign language skills.
D) none of the above
Answer: A
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
5) Historical exchange rates may be used for ________, while current exchange rates may be
used for ________.
A) fixed assets and current assets; income and expense items
B) equity accounts and fixed assets; current assets and liabilities
C) current assets and liabilities; equity accounts and fixed assets
D) equity accounts and current liabilities; current assets and fixed assets
Answer: B
Diff: 2
L.O.: 11.1 Overview of Translation
Skill: Conceptual
AACSB: Application of knowledge
6) If an imbalance results from the accounting method used for translation, the imbalance is
taken either to ________ or ________.
A) the bank; the post office
B) depreciation; the market for foreign exchange swaps
C) current income; equity reserves
D) current liabilities; equity reserves
Answer: C
Diff: 2
L.O.: 11.1 Overview of Translation
Skill: Conceptual
AACSB: Application of knowledge
7) Generally speaking, translation methods by country define the translation process as a
function of what two factors?
A) size; location
B) a firm's functional currency; location
C) location; foreign subsidiary independence
D) foreign subsidiary independence; a firm's functional currency
Answer: D
Diff: 2
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
8) A/An ________ subsidiary is one in which the firm operates as an extension of the parent
company with cash flows highly interrelated with the parent.
A) self-sustaining foreign
B) integrated foreign entity
C) foreign
D) none of the above
Answer: B
Diff: 2
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
9) Consider two different foreign subsidiaries of Georgia-Pacific Wood Products Inc. The first
subsidiary mills trees in Canada and ships its entire product to the Georgia-Pacific U.S. The
second subsidiary is also owned by the parent firm but is located in Japan and retails tropical
hardwood furniture that it buys from many different sources. The first subsidiary is likely a/an
________ foreign entity with most of its cash flows in U.S. dollars, and the second subsidiary is
more of a/an ________ foreign entity.
A) domestic; integrated
B) self-sustaining; domestic
C) integrated; self-sustaining
D) self-sustaining; integrated
Answer: C
Diff: 2
L.O.: 11.1 Overview of Translation
Skill: Conceptual
AACSB: Application of knowledge
10) A foreign subsidiary's ________ currency is the currency used in the firm's day-to-day
operations.
A) local
B) integrated
C) notational dollar
D) functional
Answer: D
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
11) The ________ determines accounting policy for U.S. firms.
A) Securities and Exchange Commission (SEC)
B) Federal Reserve System (Fed)
C) Financial Accounting Standards Board (FASB)
D) General Agreement on Tariffs and Trade (GATT)
Answer: C
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
12) It is possible to use different exchange rates for different line items on a financial statement.
Answer: TRUE
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Conceptual
AACSB: Application of knowledge
13) If the same exchange rate were used to remeasure every line on a financial statement, then
there would be no imbalances from remeasuring.
Answer: TRUE
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Conceptual
AACSB: Application of knowledge
14) A foreign subsidiary's functional currency is the currency of the primary economic
environment in which the subsidiary operates and in which it generates cash flows.
Answer: TRUE
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Conceptual
AACSB: Application of knowledge
15) It is highly unusual for a multinational firm to have both integrated foreign entities AND
self-sustaining foreign entities.
Answer: FALSE
Diff: 1
L.O.: 11.1 Overview of Translation
Skill: Recognition
AACSB: Application of knowledge
16) Most countries specify the translation method to be used by a foreign subsidiary based on its
business operations or the functional currency. Explain both subsidiary characterization criteria
and the one adopted in the United States.
Answer: A foreign subsidiary's business can be categorized as either an integrated foreign entity
or a self-sustaining foreign entity. An integrated foreign entity is one that operates as an
extension of the parent company, with cash flows and general business lines that are highly
interrelated with those of the parent. A self-sustaining foreign entity is one that operates in the
local economic environment independent of the parent company. The differentiation is important
to the logic of translation. A foreign subsidiary should be valued principally in terms of the
currency that is the basis of its economic viability. It is not unusual for a single company to have
both types of foreign subsidiaries, integrated and self-sustaining.
A foreign subsidiary's functional currency is the currency of the primary economic environment
in which the subsidiary operates and in which it generates cash flows. In other words, it is the
dominant currency used by that foreign subsidiary in its day-to-day operations. It is important to
note that the geographic location of a foreign subsidiary and its functional currency may be
different.
The United States, rather than distinguishing a foreign subsidiary as either integrated or self-
sustaining, requires that the functional currency of the subsidiary be determined. Management
must evaluate the nature and purpose of each of its individual foreign subsidiaries to determine
the appropriate functional currency for each. If a foreign subsidiary of a U.S.-based company is
determined to have the U.S. dollar as its functional currency, it is essentially an extension of the
parent company (equivalent to the integrated foreign entity designation used by most countries).
If, however, the functional currency of the foreign subsidiary is determined to be different from
the U.S. dollar, the subsidiary is considered a separate entity from the parent (equivalent to the
self-sustaining entity designation).
Diff: 2
L.O.: 11.1 Overview of Translation
Skill: Conceptual
AACSB: Application of knowledge
11.2 Translation Methods
1) The two basic methods for the translation of foreign subsidiary financial statements are the
________ method and the ________ method.
A) current rate; temporal
B) temporal; proper timing
C) current rate; future rate
D) none of the above
Answer: A
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
2) Gains or losses caused by translation adjustments when using the current rate method are
reported separately on the:
A) consolidated statement of cash flow.
B) consolidated income statement.
C) consolidated balance sheet.
D) none of the above
Answer: C
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
3) The basic advantage of the ________ method of foreign currency translation is that foreign
nonmonetary assets are carried at their original cost in the parent's consolidated statement while
the most important advantage of the ________ method is that the gain or loss from translation
does not pass through the income statement.
A) monetary; current rate
B) temporal; current rate
C) temporal; monetary
D) current rate; temporal
Answer: D
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Conceptual
AACSB: Application of knowledge
4) Under the U.S. method of translation procedures, if the financial statements of the foreign
subsidiary of a U.S. company are maintained in U.S. dollars:
A) translation is accomplished through the current rate method.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) the translation method to be used is not obvious.
Answer: C
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Conceptual
AACSB: Application of knowledge
5) Under the U.S. method of translation procedures, if the financial statements of the foreign
subsidiary of a U.S. company are maintained in the local currency, and the local currency is the
functional currency, then:
A) the translation method to be used is not obvious.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) translation is accomplished through the current rate method.
Answer: D
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Conceptual
AACSB: Application of knowledge
6) Under the U.S. method of translation procedures, if the financial statements of the foreign
subsidiary of a U.S. company are maintained in the local currency, and the U.S. dollar is the
functional currency, then:
A) translation is not required.
B) translation is accomplished through the current rate method.
C) translation is accomplished through the temporal method.
D) none of the above
Answer: C
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Conceptual
AACSB: Application of knowledge
7) Under U.S. accounting and translation practices, use of the current rate method is termed
________ while use of the temporal method is termed ________.
A) translation; the same
B) translation; remeasurement
C) remeasurement; the same
D) remeasurement; translation
Answer: B
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
8) Which of the following primary principles of U.S. translation procedures is NOT true?
A) If the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S.
dollars, translation is not required.
B) If the financial statements of the foreign subsidiary are maintained in the local currency and
the local currency is the functional currency, they are translated by the temporal method.
C) If the financial statements of the foreign subsidiary are maintained in the local currency and
the U.S. dollar is the functional currency, they are remeasured by the temporal method.
D) All of the above are true.
Answer: B
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
9) ________ occur as a result of changes in the value of currency, whereas ________ occur as a
result of ongoing business activities.
A) Operating gains or losses; translation gains or losses
B) Swap losses; translation gains or losses
C) Translation gains or losses; operating gains or losses
D) all of the above
Answer: C
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
10) Exchange rate imbalances that are passed through the balance sheet affect a firm's reported
income, but imbalances transferred to the income statement do not.
Answer: FALSE
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
11) The current rate method is the most prevalent method today for the translation of financial
statements.
Answer: TRUE
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
12) The temporal rate method is the most prevalent method today for the translation of financial
statements.
Answer: FALSE
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
13) The biggest advantage of the current rate method of reporting translation adjustments is the
fact that the gain or loss goes directly to the reserve account on the consolidated balance sheet
and does not pass through the consolidated income statement.
Answer: TRUE
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
14) Under the temporal rate method, specific assets and liabilities are translated at exchange rates
consistent with the timing of the item's creation.
Answer: TRUE
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
15) The temporal method of foreign currency translation gains or losses resulting from
remeasurement are carried directly to current consolidated income and thus introduces volatility
to consolidated earnings.
Answer: TRUE
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
16) The current rate method and the temporal method are two basic methods for translation that
are employed worldwide.
Answer: TRUE
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
17) Under U.S. accounting and translation practices, use of the current rate method is termed
"translation" while use of the temporal method is termed "remeasurement."
Answer: TRUE
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
18) If the financial statements of the foreign subsidiary are maintained in the local currency and
the U.S. dollar is the functional currency, they are remeasured by the temporal method.
Answer: TRUE
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
19) Translation gains or losses can be quite different from operating gains or losses not only in
magnitude but also in sign.
Answer: TRUE
Diff: 1
L.O.: 11.2 Translation Methods
Skill: Recognition
AACSB: Application of knowledge
20) The two methods for the translation of foreign subsidiary financial statements are the current
rate and temporal methods. Briefly, describe how each of these methods translates the foreign
subsidiary financial statements into the parent company's consolidated statements. Identify when
each technique should be used and the major advantage(s) of each.
Answer: The current rate method translates almost all line items from the foreign subsidiary to
the parent consolidated statements at the current exchange rate. This is the most commonly used
method in the world today. Assets and liabilities are translated at current exchange rate and items
found on the income statement are translated at the actual exchange rate on the date of
transaction, or as an average over the statement period where appropriate. Equity accounts are
translated at historical costs.
Any gains or losses caused by translation adjustments are typically placed into a special reserve
account (such as a CTA). Thus, gains or losses do not go through the income statement and do
not increase the volatility of net income. This is perhaps the biggest advantage to using the
current rate method.
By contrast, the temporal method assumes that several individual financial statement items are
periodically restated to reflect their market value. The temporal method translates individual line
items based on monetary/nonmonetary criteria where monetary assets such as cash and
marketable securities are translated at current exchange rates, but nonmonetary assets such as
fixed assets are translated at historical rates. The gains or losses that result from translation
remeasurement are recorded on the consolidated income statement and impact upon the volatility
of net income. The temporal method of using historical costs may be more consistent with the
practice of carrying domestic items at cost on the financial statements.
Diff: 2
L.O.: 11.2 Translation Methods
Skill: Conceptual
AACSB: Application of knowledge
11.3 Ganado Corporation's Translation Exposure
1) If the European subsidiary of a U.S. firm has net exposed assets of 750,000, and the euro
drops in value from $1.30/euro to $1.20/ the U.S. firm has a translation:
A) gain of $75,000.
B) loss of $75,000.
C) gain of $625,000.
D) loss of 576,923.
Answer: B
Diff: 3
L.O.: 11.3 Ganado Corporation's Translation Exposure
Skill: Analytical
AACSB: Analytical thinking
2) If the European subsidiary of a U.S. firm has net exposed assets of 200,000, and the euro
increases in value from $1.22/ to $1.26/ the U.S. firm has a translation:
A) gain of $8,000.
B) loss of $8,000.
C) gain of $252,000.
D) loss of 252,000.
Answer: A
Diff: 3
L.O.: 11.3 Ganado Corporation's Translation Exposure
Skill: Analytical
AACSB: Analytical thinking
3) If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound
increases in value from 1.40/£ to 1.44/£, the European firm has a translation:
A) loss of 5,000.
B) gain of 5,000.
C) gain of £5,000.
D) loss of £5,000.
Answer: B
Diff: 3
L.O.: 11.3 Ganado Corporation's Translation Exposure
Skill: Analytical
AACSB: Analytical thinking
4) If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound
drops in value from 1.35/£ to 1.30/£, the European firm has a translation:
A) gain of 12,500.
B) loss of 12,500.
C) loss of £12,500.
D) gain of £12,500.
Answer: B
Diff: 3
L.O.: 11.3 Ganado Corporation's Translation Exposure
Skill: Analytical
AACSB: Analytical thinking
5) The value contribution of a subsidiary of a multinational firm to the firm can be reported in
the income statement or balance sheet of the consolidated firm. Explain the reporting of the
changes in the value of a subsidiary as a result of the change in an exchange rate — changes to
the income and the assets of the subsidiary — in the consolidated financial statements of the
parent company.
Answer: The earnings of the subsidiary, once remeasured into the home currency of the parent
company, contributes directly to the consolidated income of the firm. An exchange rate change
results in fluctuations in the value of the subsidiary's income to the global corporation. If the
individual subsidiary in question constitutes a relatively significant or material component of
consolidated income, the multinational firm's reported income (and earnings per share, EPS) may
be seen to change purely as a result of translation.
Changes in the reporting currency value of the net assets of the subsidiary are passed into
consolidated income or equity. If the foreign subsidiary was designated as "dollar functional,"
remeasurement results in a transaction exposure, which is passed through current consolidated
income. If the foreign subsidiary was designated as "local currency functional," translation
results in a translation adjustment and is reported in consolidated equity as a translation
adjustment. It does not alter reported consolidated net income.
Diff: 2
L.O.: 11.3 Ganado Corporation's Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
11.4 Managing Translation Exposure
1) The main technique to minimize translation exposure is called a/an ________ hedge.
A) balance sheet
B) income statement
C) forward
D) translation
Answer: A
Diff: 1
L.O.: 11.4 Managing Translation Exposure
Skill: Recognition
AACSB: Application of knowledge
2) A balance sheet hedge requires that the amount of exposed foreign currency assets and
liabilities:
A) have a 2:1 ratio of assets to liabilities.
B) have a 2:1 ratio of liabilities to assets.
C) have a 2:1 ratio of liabilities to equity.
D) be equal.
Answer: D
Diff: 1
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
3) If a firm's balance sheet has an equal amount of exposed foreign currency assets and liabilities
and the firm translates by the temporal method, then:
A) the net exposed position is called monetary balance.
B) the change is value of liabilities and assets due to a change in exchange rates will be of equal
but opposite direction.
C) Both A and B are true.
D) none of the above
Answer: C
Diff: 2
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
4) If a firm's subsidiary is using the local currency as the functional currency, which of the
following is NOT a circumstance that could justify the use of a balance sheet hedge?
A) The foreign subsidiary is about to be liquidated, so that the value of its Cumulative
Translation Adjustment (CTA) would be realized.
B) The firm has debt covenants or bank agreements that state the firm's debt/equity ratio will be
maintained within specific limits.
C) The foreign subsidiary is operating is a hyperinflationary environment.
D) All of the above are appropriate reasons to use a balance sheet hedge.
Answer: D
Diff: 2
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
5) If the parent firm and all subsidiaries denominate all exposed assets and liabilities in the
parent's reporting currency this will ________ exposure but each subsidiary would have
________ exposure.
A) maximize translation; no transaction
B) eliminate translation; transaction
C) maximize transaction; no translation
D) eliminate transaction; translation
Answer: B
Diff: 2
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
6) A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S.
dollars. The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a
profit on the sale of goods. Later, when the U.S. parent pays the subsidiary the contracted U.S.
dollar amount, the Canadian dollar has appreciated 10% against the U.S. dollar. In this example,
the Canadian subsidiary will record a:
A) 10% foreign exchange loss on the U.S. dollar accounts receivable.
B) 10% foreign exchange gain on the U.S. dollar accounts receivable.
C) Since the Canadian firm is a U.S. subsidiary, neither a gain nor loss will be recorded.
D) Any gain or loss will be recorded only by the parent firm.
Answer: A
Diff: 2
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
7) ________ gains and losses are "realized" whereas ________ gains and losses are only "paper."
A) Translation; transaction
B) Transaction; translation
C) Translation; operating
D) none of the above
Answer: B
Diff: 2
L.O.: 11.4 Managing Translation Exposure
Skill: Recognition
AACSB: Application of knowledge
8) It is possible that efforts to decrease translation exposure may result in an increase in
transaction exposure.
Answer: TRUE
Diff: 1
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
9) One possible reason for a balance sheet hedge could be because the foreign subsidiary is about
to be liquidated, so that value of its Cumulative Translation Adjustment (CTA) would be
realized.
Answer: TRUE
Diff: 1
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
10) One possible reason for a balance sheet hedge could be because the firm has debt covenants
or bank agreements that state the firm's debt/equity ratios will be maintained within specific
limits.
Answer: TRUE
Diff: 1
L.O.: 11.4 Managing Translation Exposure
Skill: Recognition
AACSB: Application of knowledge
11) If management expects a foreign currency to depreciate, it could minimize translation
exposure by increasing net exposed assets.
Answer: FALSE
Diff: 1
L.O.: 11.4 Managing Translation Exposure
Skill: Recognition
AACSB: Application of knowledge
12) If management anticipates an appreciation of the foreign currency, it should decrease net
exposed assets to benefit from a gain.
Answer: FALSE
Diff: 1
L.O.: 11.4 Managing Translation Exposure
Skill: Recognition
AACSB: Application of knowledge
13) Describe a balance sheet hedge and give at least two examples of when such a hedge could
be justified.
Answer: A balance sheet hedge attempts to equalize the amount of assets and liabilities of a
foreign subsidiary exposed to translation risk. Thus, the gain to the firm from a change in
exchange rates will be perfectly offset by an equal and opposite loss. Firms may engage in
balance sheet hedges under conditions of hyperinflation, or when the subsidiary is about to be
liquidated and the value of the CTA account would be realized. The author on page 16 lists other
examples.
Diff: 3
L.O.: 11.4 Managing Translation Exposure
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 12 Operating Exposure
12.1 A Multinational's Operating Exposure
1) Another name for operating exposure is ________ exposure.
A) economic
B) competitive
C) strategic
D) all of the above
Answer: D
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
2) What type of international risk exposure measures the change in present value of a firm
resulting from changes in future operating cash flows caused by any unexpected change in
exchange rates?
A) transaction exposure
B) accounting exposure
C) operating exposure
D) translation exposure
Answer: C
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
3) ________ cash flows arise from intracompany and intercompany receivables and payments,
while ________ cash flows are payments for the use of loans and equity.
A) Financing; operating
B) Operating; financing
C) Operating; accounting
D) Accounting; financing
Answer: B
Diff: 2
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT an example of a financial cash flow?
A) parent invested equity capital
B) interest on intrafirm lending
C) payment for goods and services
D) intrafirm principal payments
Answer: C
Diff: 2
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
5) Which of the following is NOT an example of an operating cash flow?
A) management fees and distributed overhead
B) royalties and license fees
C) rent and lease payments
D) dividend paid to parent company
Answer: D
Diff: 2
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
6) ________ exposure is far more important for the long-run health of a business than changes
caused by ________ or ________ exposure.
A) Operating; translation; transaction
B) Transaction; operating; translation
C) Accounting; translation; transaction
D) Translation; operating; transaction
Answer: A
Diff: 2
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
7) Simpson Sign Company based in Frostbite Falls, Minnesota has a 6-month C$100,000
contract to complete sign work in Winnipeg, Manitoba, Canada. The current spot rate is
$1.02/C$ and the forward rate is $1.01/C$. Under conditions of equilibrium, management would
use ________ today when preparing operating budgets.
A) $102,000
B) $101,000
C) $100,000
D) none of the above
Answer: B
Diff: 3
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Analytical
AACSB: Analytical thinking
8) When considering the phases of adjustment and response to operating exposure in the LONG
RUN, price changes tend to be ________ and volume changes tend to be ________.
A) fixed/contracted; contracted.
B) fixed/contracted; completely flexible.
C) completely flexible; completely flexible.
D) completely flexible; contracted.
Answer: C
Diff: 2
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
9) The goal of operating exposure analysis is to identify strategic operating techniques the firm
might adopt to enhance value in the face of unanticipated exchange rate changes.
Answer: TRUE
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
10) Operating cash flows may occur in different currencies and at different times, but financing
cash flows may occur only in a single currency.
Answer: FALSE
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
11) Expected changes in foreign exchange rates should already be factored into anticipated
operating results by management and investors.
Answer: TRUE
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
12) Even though contracts are often fixed in the short run, as time passes, prices and costs can be
changed to reflect the new competitive realities caused by a change in exchange rates.
Answer: TRUE
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
13) The higher the price elasticity of demand, the higher the degree of pass-through.
Answer: FALSE
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
14) An unexpected change in exchange rates impacts a firm's expected cash flows at three levels,
depending on the time horizon used (Short Run, Medium Run, and Long Run). Describe the
three operating exposure's phases of adjustment assuming that parity conditions do not hold
among foreign exchange rates, national inflation rates, and national interest rates
(disequilibrium).
Answer: The first level impact is on expected cash flows in the one-year operating budget. The
gain or loss depends on the currency of denomination of expected cash flows. These are both
existing transaction exposures and anticipated exposures. The currency of denomination cannot
be changed for existing obligations, or even for implied obligations such as purchase or sales
commitments. In the short run it is difficult to change sales prices or renegotiate factor costs.
Therefore, realized cash flows will differ from those expected in the budget.
The second level impact is on expected medium-run cash flows assuming disequilibrium
conditions. In this case, the firm may not be able to adjust prices and costs to reflect the new
competitive realities caused by a change in exchange rates. The primary problem may be the
reactions of existing competitors. The firm's realized cash flows will differ from its expected
cash flows. The firm's market value may change because of the unanticipated results.
The third level impact is on expected long-run cash flows, meaning those beyond five years. At
this strategic level a firm's cash flows will be influenced by the reactions of both existing
competitors and potential competitors-possible new entrants-to exchange rate changes under
disequilibrium conditions. In fact, all firms that are subject to international competition, whether
they are purely domestic or multinational, are exposed to foreign exchange operating exposure in
the long run whenever foreign exchange markets are not continuously in equilibrium.
Diff: 1
L.O.: 12.1 A Multinational's Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
12.2 Measuring Operating Exposure: Ganado Germany
1) Recently the British Pound suffered an unexpected depreciation in value. Which of the
following actions being considered by Coventry Furniture of London, a purely domestic
furniture manufacturer and retailer, would be considered a highly unlikely response to the
depreciation of the pound?
A) Coventry might choose to maintain its domestic sales prices constant in pound terms.
B) Coventry might try to raise domestic prices because competing imports are now priced higher
in England.
C) Coventry might try to lower domestic prices because competing imports are now priced
higher in England.
D) none of the above
Answer: C
Diff: 2
L.O.: 12.2 Measuring Operating Exposure: Ganado Germany
Skill: Recognition
AACSB: Application of knowledge
2) Recently the Canadian dollar realized an unexpected appreciation in value. Which of the
following actions being considered by Tall Timber Exports, a Canadian logging firm specializing
in exporting raw forest products, would be considered a highly unlikely response to the
appreciation of the Canadian dollar?
A) Tall Timber Exports might lower export prices in an effort to maintain market share.
B) Tall Timber Exports might raise export prices only slightly in an effort to increase market
share.
C) Tall Timber Exports might leave export prices as they are and wait to determine what actions
to take if any in the future.
D) all of the above
Answer: B
Diff: 2
L.O.: 12.2 Measuring Operating Exposure: Ganado Germany
Skill: Recognition
AACSB: Application of knowledge
3) For a firm that competes internationally to sell its products, a depreciation of its domestic
currency relative to markets where the firm exports goods, should eventually result in ________
sales at home and ________ sales abroad, other things equal.
A) fewer; greater
B) fewer; fewer
C) greater; greater
D) greater; fewer
Answer: C
Diff: 2
L.O.: 12.2 Measuring Operating Exposure: Ganado Germany
Skill: Conceptual
AACSB: Application of knowledge
4) Brimmo Motorcycles Inc., a U.S.-based firm, manufactures and sells electric motorcycles both
domestically and internationally. A sudden and unexpected appreciation of the U.S. dollar should
allow sales to ________ at home and ________ abroad. (Assume other factors remain
unchanged.)
A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase
Answer: B
Diff: 2
L.O.: 12.2 Measuring Operating Exposure: Ganado Germany
Skill: Conceptual
AACSB: Application of knowledge
5) The strategy management undertakes in response to unexpected changes in exchange rates
depends to a large measure on their opinion about the price elasticity of demand.
Answer: TRUE
Diff: 1
L.O.: 12.2 Measuring Operating Exposure: Ganado Germany
Skill: Recognition
AACSB: Application of knowledge
6) Unexpected changes in exchange rates is never good news for a firm's operating income.
Answer: FALSE
Diff: 1
L.O.: 12.2 Measuring Operating Exposure: Ganado Germany
Skill: Conceptual
AACSB: Application of knowledge
12.3 Strategic Management of Operating Exposure
1) Which of the following is NOT an example of diversifying operations?
A) diversifying sales
B) diversifying location of operations
C) raising funds in more than one country
D) sourcing raw materials in more than one country
Answer: C
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT an example of diversification in financing?
A) raising funds in more than one market
B) raising funds in more than one country
C) diversifying sales
D) All of the above qualify.
Answer: C
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
3) When disequilibria in international markets occur, management can take advantage by:
A) doing nothing if they are already diversified and able to realize beneficial portfolio effects.
B) recognizing disequilibria faster than purely domestic competitors.
C) shifting operational of financing activities to take advantage of the disequilibria.
D) all of the above
Answer: D
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
4) Purely domestic firms will be at a disadvantage to MNEs in the event of market disequilibria
because:
A) domestic firms lack comparative data from its own sources.
B) international firms are already so large.
C) all of the domestic firm's raw materials are imported.
D) None of the above; domestic firms are not at a disadvantage.
Answer: A
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
5) Which of the following is probably NOT an advantage of foreign exchange risk management?
A) the reduction of the variability of cash flows due to domestic business cycles
B) increased availability of capital
C) reduced cost of capital
D) All of the above are potential advantages of foreign exchange risk management.
Answer: D
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
6) Which of the following is NOT an example of a form of political risk that might be avoided or
reduced by foreign exchange risk management?
A) expropriation of assets
B) destruction of raw materials through natural disaster
C) war
D) unfavorable legal changes
Answer: B
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
7) Moral hazard may occur when a firm or individual takes on more risk when it knows that
someone else will "pick up the tab."
Answer: TRUE
Diff: 1
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
8) Management must be able to predict disequilibria in international markets to take advantage of
diversification strategies.
Answer: FALSE
Diff: 1
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
9) If a firm diversifies its financing sources, it will be pre-positioned to take advantage of
temporary deviations from the International Fisher Effect.
Answer: TRUE
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
10) Diversifying the financing base means diversifying sales, location of production facilities,
and raw material sources.
Answer: FALSE
Diff: 1
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
11) The variability of a firm's operating cash flows is probably reduced by international
diversification of its production, sourcing, and sales because exchange rate changes under
disequilibrium conditions are likely to increase the firm's competitiveness in some markets while
reducing it in others.
Answer: TRUE
Diff: 2
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
12) Diversification is possibly the best technique for reducing the problems associated with
international transactions. Provide one example each of international financial diversification and
international operational diversification and explain how the action reduces risk.
Answer: An MNE well known in the financial markets could borrow money in a country in
which the firm receives foreign currency. The MNE could then use the receivables to repay the
loan in the foreign currency and avoid uncertainties in exchange rates.
An MNE could establish production facilities in several countries. This could be beneficial in at
least two ways. First, such diversification reduces the probability of unfavorable changes in
exchange rates for one country from significantly reducing the firm's profitability. Second, an
MNE with facilities in several countries is well positioned by using internal sources to recognize
when a disequilibrium in the market arises.
Diff: 3
L.O.: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
12.4 Proactive Management of Operating Exposure
1) Which of the following is NOT identified by your authors as a proactive management
technique to reduce exposure to foreign exchange risk?
A) matching currency cash flows
B) cross-currency swaps
C) remaining a purely domestic firm
D) parallel loans
Answer: C
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
2) Which one of the following management techniques is likely to best offset the risk of long-run
exposure to receivables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Increase sales to that country.
D) Increase sales in this country.
Answer: A
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
3) Which one of the following management techniques is likely to best offset the risk of long-run
exposure to payables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Rely on the Federal Reserve Board to enact monetary policy favorable to your exposure risk.
D) none of the above
Answer: B
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
4) The particular strategy of trying to offset stable inflows of cash from one country with
outflows of cash in the same currency is known as:
A) hedging.
B) diversification.
C) matching.
D) balancing.
Answer: C
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
5) Which of the following is NOT an acceptable hedging technique to reduce risk caused by a
relatively predictable long-term foreign currency inflow of Japanese yen?
A) Import raw materials from Japan denominated in yen to substitute for domestic suppliers.
B) Pay suppliers from other countries in yen.
C) Import raw materials from Japan denominated in dollars.
D) Acquire debt denominated in yen.
Answer: C
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
6) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the
firm chooses to hedge by seeking out potential suppliers in Japan. This hedging strategy is
referred to as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.
Answer: A
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
7) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the
firm chooses to hedge by paying for imports from Canada in Japanese yen. This hedging strategy
is known as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.
Answer: B
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
8) A U.S. timber products firm has a long-term contract to import unprocessed logs from
Canada. To avoid occasional and unpredictable changes in the exchange rate between the U.S.
dollar and the Canadian dollar, the firms agree to split between the two firms the impact of any
exchange rate movement. This type of agreement is referred to as:
A) risk-sharing.
B) currency-switching.
C) matching.
D) a natural hedge.
Answer: A
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
9) A ________ occurs when two business firms in separate countries arrange to borrow each
other's currency for a specified period of time.
A) natural hedge loan
B) forward loan
C) currency switch loan
D) back-to-back loan
Answer: D
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
10) A Canadian firm with a U.S. subsidiary and a U.S. firm with a Canadian subsidiary agree to
a parallel loan agreement. In such an agreement, the Canadian firm is making a/an ________
loan to the ________ subsidiary while effectively financing the ________ subsidiary.
A) indirect; U.S.; Canadian
B) indirect; Canadian; U.S.
C) direct; U.S.; Canadian
D) direct; Canadian; U.S.
Answer: C
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
11) Which of the following is NOT an important impediment to widespread use of parallel
loans?
A) difficulty in finding an appropriate counterparty
B) the risk that one of the parties will fail to return the borrowed funds when agreed
C) the process does not avoid exchange rate risk
D) All of the above are significant impediments.
Answer: C
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
12) A ________ resembles a back-to-back loan except that it does not appear on a firm's balance
sheet.
A) forward loan
B) currency hedge
C) counterparty
D) currency swap
Answer: D
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
13) A ________ is the term used to describe a foreign currency agreement between two parties to
exchange a given amount of one currency for another, and after a period of time, to give back the
original amounts.
A) matched flow
B) currency swap
C) back-to-back loan
D) none of the above
Answer: B
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
14) A British firm and a U.S. Corporation each wish to enter into a currency swap hedging
agreement. The British firm is receiving U.S. dollars from sales in the U.S. but wants pounds.
The U.S. firm is receiving pounds from sales in Britain but wants dollars. Which of the following
choices would best satisfy the desires of the firms?
A) The British firm pays dollars to a swap dealer and receives pounds from the dealer. The U.S.
firm pays pounds to the swap dealer and receives dollars.
B) The U.S. firm pays dollars to a swap dealer and receives pounds from the dealer. The British
firm pays pounds to the swap dealer and receives dollars.
C) The British firm pays pounds to a swap dealer and receives pounds from the dealer. The U.S.
firm pays dollars to the swap dealer and receives dollars.
D) The British firm pays dollars to a swap dealer and receives dollars from the dealer. The U.S.
firm pays pounds to the swap dealer and receives pounds.
Answer: A
Diff: 3
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
15) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from the
Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar
against the Canadian dollar NRI is finding a continued relationship with ATC to be an
increasingly difficult proposition. In response to NRI's request, ATC has proposed the following
risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates
stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range,
ATC will share equally with NRI the difference between the spot rate and the base rate. If the
current spot rate is C$1.20/$, what are the upper and lower limits for trading to take place at
C$1.20?
A) C$1.205/$ - C$1.195/$
B) C$1.15/$ - C$1.25/$
C) C$1.14/$ - C$1.26/$
D) none of the above
Answer: C
Diff: 3
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Analytical
AACSB: Analytical thinking
16) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from The
Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar
against the Canadian dollar NRI is finding a continued relationship with ATC to be an
increasingly difficult proposition. In response to NRI's request, ATC has proposed the following
risk-sharing arrangement. First, set the current spot rate of C$1.20/$as the base rate. As long as
spot rates stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5%
range, ATC will share equally with NRI the difference between the spot rate and the base rate. If
NRI had a payable of C$100,000 due today and the current spot rate were C$1.17/$, how much
would NRI owe in U.S. dollars?
A) $83,333
B) $85,470
C) $85,837
D) $117,000
Answer: A
Diff: 3
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Analytical
AACSB: Analytical thinking
17) Costs associated with the purchase of sizeable put options positions include each of the
following EXCEPT:
A) the purchase price of the options.
B) the opportunity cost of buying the options rather than diversifying operations to reduce risk.
C) executive salaries of having corporate offices in more than one country.
D) none of the above
Answer: C
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
18) Currency swaps are exclusively for periods of time under one year.
Answer: FALSE
Diff: 1
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
19) Most swap dealers arrange swaps so that each firm that is a party to the transaction does not
know who the counterparty is.
Answer: TRUE
Diff: 1
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
20) Most swap dealers arrange swaps so that each firm that is a party to the transaction knows
who the counterparty is.
Answer: FALSE
Diff: 1
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
21) Swap agreements are treated as off-balance sheet transactions via U.S. accounting methods.
Answer: TRUE
Diff: 1
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
22) Swap agreements are treated as line items on the balance sheet via U.S. accounting methods.
Answer: FALSE
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
23) After being introduced in the 1980s, currency swaps have remained a relatively insignificant
financial derivative instrument.
Answer: FALSE
Diff: 1
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
24) After being introduced in the 1980s, currency swaps have gained increasing importance as
financial derivative instruments.
Answer: TRUE
Diff: 1
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
25) The empirical evidence strongly supports the proposition that contractual hedges can
effectively eliminate operating exposure.
Answer: FALSE
Diff: 2
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Recognition
AACSB: Application of knowledge
26) A British firm has a subsidiary in the U.S., and a U.S. firm, known to the British firm, has a
subsidiary in Britain. Define and then provide an example for each of the following management
techniques for reducing the firm's operating cash flows. The following are techniques to
consider:
a) matching currency cash flows
b) risk-sharing agreements
c) back-to-back or parallel loans
Answer:
a) Matching currency cash flows requires that the British firm with dollar receivables must
establish an equivalent dollar payable. They could do this by borrowing dollars and repaying the
loan with the proceeds from the receivables account. Or they could move all or part of their
operations to the U.S. so that both receivables and payables would be in U.S. dollars.
b) Risk-sharing agreements are contractual clauses whereby both parties agree to an acceptable
range of exchange rates at the time the international sale is made. A spot rate at time of exchange
outside of the agreed upon range results in an adjustment made to the actual exchange rate that
shares the difference between the spot rate and the acceptable range of exchange rates.
c) Back-to-back loans provide for parent-subsidiary cross border financing without incurring
direct currency exposure. For example, using our British and U.S. firms, the British firm could
lend pounds to the U.S. subsidiary in Britain at the same time that the U.S. firm lends an
equivalent amount of dollars to the British subsidiary in the U.S. Later, the loans would be
simultaneously repaid.
Diff: 3
L.O.: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 13 Global Cost and Availability of Capital
13.1 Financial Globalization and Strategy
1) If a firm lies within a country with ________ or ________ domestic capital markets, it can
achieve lower global cost and greater availability of capital with a properly designed and
implemented strategy to participate in international capital markets.
A) liquid; segmented
B) liquid; large
C) illiquid; segmented
D) large; illiquid
Answer: C
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
2) Other things equal, a firm that must obtain its long-term debt and equity in a highly illiquid
domestic securities market will probably have a:
A) relatively low cost of capital.
B) relatively high cost of capital.
C) relatively average cost of capital.
D) cost of capital that we cannot estimate from this question.
Answer: B
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
3) Relatively high costs of capital are more likely to occur in:
A) highly illiquid domestic securities markets.
B) highly liquid domestic securities markets.
C) unsegmented domestic securities markets.
D) none of the above
Answer: A
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
4) Reasons that firms may find themselves with relatively high costs of capital include:
A) The firms reside in emerging countries with undeveloped capital markets.
B) The firms are too small to easily gain access to their own national securities market.
C) The firms are family owned and they choose not to access public markets and lose control of
the firm.
D) all of the above
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
5) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) excessive regulatory control
B) perceived political risk
C) anticipated foreign exchange risk
D) All of the above are contributing factors.
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
6) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) lack of transparency
B) asymmetric availability of information
C) insider trading
D) All of the above are contributing factors.
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
7) The weighted average cost of capital (WACC) is:
A) the required rate of return for all of a firm's capital investment projects.
B) the required rate of return for a firm's average risk projects.
C) not applicable for use by MNE.
D) equal to 13%.
Answer: B
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
8) The capital asset pricing model (CAPM) is an approach:
A) to determine the price of equity capital.
B) used by marketers to determine the price of saleable product.
C) that can be applied only to domestic markets.
D) none of the above
Answer: A
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
9) Which of the following is NOT a key variable in the equation for the capital asset pricing
model?
A) the risk-free rate of interest
B) the expected rate of return on the market portfolio
C) the marginal tax rate
D) All are important components of the CAPM.
Answer: C
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
10) ________ risk is a function of the variability of expected returns of the firm's stock relative
to the market index and the measure of correlation between the expected returns of the firm and
the market.
A) Systematic
B) Unsystematic
C) Total
D) Diversifiable
Answer: A
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
11) Systematic risk:
A) is the standard deviation of a security's return.
B) is measured with beta.
C) is measured with standard deviation.
D) none of the above
Answer: B
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
12) Which of the following is generally unnecessary in measuring the cost of debt?
A) a forecast of future interest rates
B) the proportions of the various classes of debt a firm proposes to use
C) the corporate income tax rate
D) All of the above are necessary for measuring the cost of debt.
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
13) The after-tax cost of debt is found by:
A) dividing the before-tax cost of debt by (1 - the corporate tax rate).
B) subtracting (1 - the corporate tax rate) from the before-tax cost of debt.
C) multiplying the before-tax cost of debt by (1 - the corporate tax rate).
D) subtracting the corporate tax rate from the before-tax cost of debt.
Answer: C
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
14) A firm whose equity has a beta of 1.0:
A) has greater systematic risk than the market portfolio.
B) stands little chance of surviving in the international financial market place.
C) has less systematic risk than the market portfolio.
D) None of the above is true.
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
15) The difference between the expected (or required) return for the market portfolio and the
risk-free rate of return is referred to as:
A) beta.
B) the geometric mean.
C) the market risk premium.
D) the arithmetic mean.
Answer: C
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
16) If a company fails to accurately predict it's cost of equity, then:
A) the firm's WACC will also be inaccurate.
B) the firm may not be using the proper interest rate to estimate NPV.
C) the firm may incorrectly accept or reject projects based on decisions made using the cost of
capital computed with an incorrect cost of equity.
D) All of the above are true.
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
17) Which of the following statements is NOT true regarding beta?
A) Beta will have a value of less than 1.0 if the firm's returns are less volatile than the market.
B) Beta will have a value of greater than 1.0 if the firm's returns are more volatile than the
market.
C) Beta will have a value of equal to 1.0 if the firm's returns are of equal volatility to the market.
D) All of the statements above are true.
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
18) Which of the following will NOT affect a firm's beta?
A) the choice of the market portfolio against which to compare the variability of a firm's returns
B) the choice of the risk-free security
C) the choice of the time period used to calculate the firm's beta
D) None of the above, because each of them affects the calculation of a firm's beta.
Answer: B
Diff: 1
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
19) Beta may be defined as:
A) the measure of systematic risk.
B) a risk measure of a portfolio.
C) the ratio of the variance of the portfolio to the variance of the market.
D) all of the above
Answer: D
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
20) ________ risk is measured with beta.
A) Systematic
B) Unsystematic
C) International
D) Domestic
Answer: A
Diff: 1
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
21) A fully diversified domestic portfolio has a beta of:
A) 0.0.
B) 1.0.
C) -1.0.
D) There is not enough information to answer this question.
Answer: B
Diff: 1
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
22) Unsystematic risk:
A) is the remaining risk in a well-diversified portfolio.
B) is measured with beta.
C) can be diversified away.
D) all of the above
Answer: C
Diff: 1
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
23) A national securities market is segmented if the required rate of return on securities in that
market differs from comparable securities traded in other, unsegmented markets.
Answer: TRUE
Diff: 1
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
24) Other things equal, an increase in the firm's tax rate will increase the WACC for a firm that
has both debt and equity financing.
Answer: FALSE
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
25) If a firm's expected returns are more volatile than the expected return for the market
portfolio, it will have a beta less than 1.0.
Answer: FALSE
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
26) The WACC is usually used as the risk-adjusted required rate of return for new projects that
are of the same average risk as the firm's existing projects.
Answer: TRUE
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
27) Firms acquire debt in either the form of loans from commercial banks, or by selling new
common stock.
Answer: FALSE
Diff: 1
L.O.: 13.1 Financial Globalization and Strategy
Skill: Recognition
AACSB: Application of knowledge
28) When estimating an average corporate after-tax cost of capital, the component cost of equity
is multiplied by (1-t) to allow for the tax-deductibility of dividend payments.
Answer: FALSE
Diff: 2
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
29) What are the components of the weighted average cost of capital (WACC) and how do they
differ for an MNE compared to a purely domestic firm?
Answer: The WACC considers the proportion or weight of assets financed with debt and the
proportion financed with equity. It also looks at the costs of debt and equity financing and the
firm's corporate tax rate. The difficulty of such a computation is compounded for an MNE
because there are several additional sources of debt financing with different required rates of
return and tax rates for an MNE than for a domestic firm. Also, equity may be sourced in several
different markets and subject to several different regulations of several different countries.
Adding regulatory oversight, multiple sourcing locations, and differing investor expectations
may significantly complicate the process of determining an MNE's cost of capital.
Diff: 3
L.O.: 13.1 Financial Globalization and Strategy
Skill: Conceptual
AACSB: Application of knowledge
13.2 International Portfolio Theory and Diversification
1) In general, the geometric mean will be ________ the arithmetic mean for a series of returns.
A) less than
B) greater than
C) equal to
D) greater than or equal to
Answer: A
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Recognition
AACSB: Application of knowledge
2) The beginning share price for a security over a three-year period was $50. Subsequent year-
end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric
average annual rate of return for this stock were:
A) 9.30% and 8.58% respectively.
B) 9.30% and 7.89% respectively.
C) 9.30% and 7.03% respectively.
D) 9.30% and 6.37% respectively.
Answer: A
Diff: 3
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Analytical
AACSB: Application of knowledge
3) A well-diversified portfolio has about ________ of the risk of the typical individual stock.
A) 8%
B) 19%
C) 27%
D) 52%
Answer: C
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Recognition
AACSB: Application of knowledge
4) An internationally diversified portfolio:
A) should result in a portfolio with a lower beta than a purely domestic portfolio.
B) has the same overall risk shape as a purely domestic portfolio.
C) is only about 12% as risky as the typical individual stock.
D) all of the above
Answer: D
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
5) In some respects, internationally diversified portfolios are the same in principle as a domestic
portfolio because:
A) the investor is attempting to combine assets that are perfectly correlated.
B) investors are trying to reduce systematic risk.
C) investors are trying to reduce the total risk of the portfolio.
D) all of the above
Answer: C
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
6) In some respects, internationally diversified portfolios are different from a domestic portfolio
because:
A) investors may also acquire foreign exchange risk.
B) international portfolio diversification increases expected return but does not decrease risk.
C) investors must leave the country to acquire foreign securities.
D) all of the above
Answer: A
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
Instruction 13.1:
Use the information to answer the following question(s).
In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a
then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.
7) Refer to Instruction 13.1. How many euros will the U.S. investor acquire with his initial
$500,000 investment?
A) 650,000
B) 370,370
C) 500,000
D) 384,615
Answer: D
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Analytical
AACSB: Application of knowledge
8) Refer to Instruction 13.1. At an average price of 60/share, how many shares of stock will the
investor be able to purchase?
A) 8333 shares
B) 6410 shares
C) 6173 shares
D) 10,833 shares
Answer: B
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Analytical
AACSB: Application of knowledge
9) Refer to Instruction 13.1. At the end of the year the investor sells his stock that now has an
average price per share of 57. What is the investor's average rate of return before converting the
stock back into dollars?
A) 5.0%
B) -3.0%
C) -5.0%
D) 3.0%
Answer: C
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Analytical
AACSB: Application of knowledge
10) Refer to Instruction 13.1. At the end of the year the investor sells his stock that now has an
average price per share of 57. What is the investor's average rate of return after converting the
stock back into dollars?
A) -1.35%
B) 5.0%
C) -5.0%
D) -7.24%
Answer: A
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Analytical
AACSB: Application of knowledge
11) A U.S. investor makes an investment in Britain and earns 14% on the investment while the
British pound appreciates against the U.S. dollar by 8%. What is the investor's total return?
A) 22.00%
B) 23.12%
C) 6.00%
D) 4.88%
Answer: B
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Analytical
AACSB: Application of knowledge
12) Which of the following statements is NOT true?
A) International diversification benefits induce investors to demand foreign securities.
B) An international security adds value to a portfolio if it reduces risk without reducing return.
C) Investors will demand a security that adds value.
D) All of the above are true.
Answer: D
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
13) International CAPM (ICAPM) assumes that there is a global market in which the firm's
equity trades, and estimates of the firm's beta, and the market risk premium, must then reflect
this global portfolio.
Answer: TRUE
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
14) Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a
purely domestic market portfolio had been used in the estimation of the cost of equity.
Answer: FALSE
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
15) A global portfolio is an index of all the securities in the world, whereas a world portfolio
represents those securities actually available to an investor.
Answer: FALSE
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Recognition
AACSB: Application of knowledge
16) The CAPM has now become very widely accepted in global business as the preferred
method of calculating the cost of equity for a firm. As a result of this, there is now little debate
over what numerical values should be used in its application.
Answer: FALSE
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
17) The geometric mean will, in all but a few extreme circumstances, yield a larger return than
the arithmetic mean return.
Answer: FALSE
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Recognition
AACSB: Application of knowledge
18) Portfolio diversification can eliminate 100% of risk.
Answer: FALSE
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
19) Increasing the number of securities in a portfolio reduces the unsystematic risk but not the
systematic risk.
Answer: TRUE
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
20) International diversification benefits may induce investors to demand foreign securities.
Answer: TRUE
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
21) If the addition of a foreign security to the portfolio of the investor aids in the reduction of
risk for a given level of return, then the security adds value to the portfolio.
Answer: TRUE
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
22) If the addition of a foreign security to the portfolio of the investor decreases the expected
return for a given level of risk, then the security adds value to the portfolio.
Answer: FALSE
Diff: 1
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
23) One of the elegant beauties of international equity markets is that over the last 100 or so
years, the average market risk premium is almost identical across major industrial countries.
Answer: FALSE
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Recognition
AACSB: Application of knowledge
24) There are potential benefits and risks from raising capital on global markets. Discuss the pros
and cons in terms of risk of raising capital on global markets.
Answer: A portfolio of international stocks represents a portfolio in which foreign securities
have been added. It has the same overall risk shape as the U.S. stock portfolio, but it has a lower
portfolio beta. This means that the international portfolio's market risk is lower than that of a
domestic portfolio. This situation arises because the returns on the foreign stocks are not
perfectly correlated with U.S. stocks (the benefits of international diversification).
The foreign exchange risks of a portfolio, whether it is a securities portfolio or the general
portfolio of activities of the MNE, are reduced through international diversification. But
international portfolio construction is also different in that when the investor acquires assets or
securities from outside the investor's host-country market, the investor may also be acquiring a
foreign currency-denominated asset. Thus, the investor has actually acquired two additional
assets—the currency of denomination and the asset subsequently purchased with the currency—
one asset in principle, but two in expected returns and risks. You should see, however, that the
presence of currency risk may alter the correlations associated with securities in different
countries and currencies.
Diff: 2
L.O.: 13.2 International Portfolio Theory and Diversification
Skill: Conceptual
AACSB: Application of knowledge
13.3 The Role of International Portfolio Investors
1) The primary goal of both domestic and international portfolio managers is:
A) to maximize return for a given level of risk, or to minimize risk for a given level of return.
B) to minimize the number of unique securities held in their portfolio.
C) to maximize their WACC.
D) all of the above
Answer: A
Diff: 1
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Conceptual
AACSB: Application of knowledge
2) Which of the following is NOT a portfolio diversification technique used by portfolio
managers?
A) diversify by type of security
B) diversify by the size of capitalization of the securities held
C) diversify by country
D) All of the above are diversification techniques.
Answer: D
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
3) If all capital markets are fully integrated, securities of comparable expected return and risk
should have the same required rate of return in each national market after adjusting for:
A) time of day and language requirements.
B) political risk and time lags.
C) foreign exchange risk and political risk.
D) foreign exchange risk and the spot rate.
Answer: C
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
4) Capital market segmentation is a financial market imperfection caused mainly by:
A) government constraints.
B) institutional practices.
C) investor perceptions.
D) all of the above
Answer: D
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
5) Capital market imperfections leading to financial market segmentation include:
A) asymmetric information between domestic and foreign-based investors.
B) high securities transaction costs.
C) foreign exchange risks.
D) all of the above
Answer: D
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
6) Capital market imperfections leading to financial market segmentation include:
A) political risks.
B) corporate governance differences.
C) regulatory barriers.
D) all of the above
Answer: D
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
7) The authors refer to companies that have access to a ________ as MNEs, and firms without
such access are identified as ________.
A) global cost and availability of capital; domestic firms
B) large domestic capital market; geographically challenged
C) world financial markets; antiquated
D) none of the above
Answer: A
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
8) The MNE can ________ its ________ by gaining access to markets that are more liquid
and/or less segmented than its own.
A) increase; MCC
B) decrease; MCC
C) maintain; MRR
D) none of the above
Answer: B
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
9) Portfolio theory assumes that investors are risk-averse. This means that investors:
A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.
Answer: C
Diff: 1
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Conceptual
AACSB: Application of knowledge
10) The optimal capital budget:
A) occurs where the marginal cost of capital equals the marginal rate of return of the opportunity
set of projects.
B) is typically larger for purely domestic firms than for MNEs.
C) is an illusion found only in international finance textbooks.
D) none of the above
Answer: A
Diff: 1
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
11) Internationally diversified portfolios often have a lower rate of return and almost always
have a higher level of portfolio risk than their domestic counterparts.
Answer: FALSE
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Conceptual
AACSB: Application of knowledge
12) Empirical tests of market efficiency fail to show that most major national markets are
reasonably efficient.
Answer: FALSE
Diff: 1
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
13) A MNE's marginal cost of capital is constant for considerable ranges in its capital budget, but
this statement cannot be made for most domestic firms.
Answer: TRUE
Diff: 1
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Conceptual
AACSB: Application of knowledge
14) Capital market segmentation is a financial market imperfection caused mainly by
government constraints, institutional practices, and investor perceptions.
Answer: TRUE
Diff: 1
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
15) Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a
result of this, the correlation among securities markets has increased, thereby reducing, but not
eliminating, the benefits of international portfolio diversification.
Answer: TRUE
Diff: 1
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Recognition
AACSB: Application of knowledge
16) Capital market segmentation is a financial market imperfection caused mainly by
government constraints, institutional practices, and investor perceptions. List and explain three
imperfections.
Answer: The following are the most important imperfections: 1) Asymmetric information
between domestic and foreign-based investors, 2) Lack of transparency, 3) High securities
transaction costs, 4) Foreign exchange risks, 5) Political risks, 6) Corporate governance
differences, 7) Regulatory barriers.
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Conceptual
AACSB: Application of knowledge
17) Market imperfections do not necessarily imply that national securities markets are
inefficient. Develop an argument as to why this is possible.
Answer: A national securities market can be efficient in a domestic context and yet segmented
in an international context. According to finance theory, a market is efficient if security prices in
that market reflect all available relevant information and adjust quickly to any new relevant
information. According to finance theory, a market is efficient if security prices in that market
reflect all available relevant information and adjust quickly to any new relevant information.
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Conceptual
AACSB: Application of knowledge
18) Most observers believe that for better or for worse, we have achieved a global market for
securities. Discuss the major changes in the international markets of securities: during the 1980s,
during the 1990s and the current conditions.
Answer: During the 1980s, numerous firms cross-listed on major foreign exchanges and were
successful in lowering their WACC and increasing its availability. During the 1990s, national
restrictions on cross-border portfolio investment were gradually eased under pressure from the
Organization for Economic Cooperation and Development. Liberalization of European securities
markets was accelerated because of the European Union's efforts to develop a single European
market without barriers. Emerging nation markets followed suit, as did the former Eastern Bloc
countries after the breakup of the Soviet Union. Emerging national markets have often been
motivated by the need to source foreign capital to finance large-scale privatization.
Now, market segmentation has been significantly reduced, although the liquidity of individual
national markets remains limited. The good news is that many firms have been assisted to
become MNEs because they now have access to a global cost and availability of capital. The bad
news is that the correlation among securities markets has increased, thereby reducing, but not
eliminating, the benefits of international portfolio diversification. Globalization of securities
markets has also led to more volatility and speculative behavior, as shown by the emerging
market crises of the 1995-2001 period, and the 2008-2009 global credit crisis.
Diff: 2
L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors
Skill: Conceptual
AACSB: Application of knowledge
13.4 The Cost of Capital for MNEs Compared to Domestic Firms
1) Theoretically, most MNEs should be in a position to support higher ________ than their
domestic counterparts because their cash flows are diversified internationally.
A) equity ratios
B) debt ratios
C) temperatures
D) none of the above
Answer: B
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Conceptual
AACSB: Application of knowledge
2) According to your authors, diversifying cash flows internationally may help MNEs reduce the
variability of cash flows because:
A) of a lack of competition among international firms.
B) of an offset to cash flow variability caused by exchange rate variability.
C) returns are not perfectly correlated between countries.
D) none of the above
Answer: C
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
3) Which of the following statements is NOT true regarding MNEs when compared to purely
domestic firms?
A) MNEs tend to rely more on short and intermediate term debt.
B) MNEs have greater foreign exchange risk.
C) MNEs have greater costs of asymmetric information.
D) MNEs have higher agency costs.
Answer: A
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Conceptual
AACSB: Application of knowledge
4) Empirical research has found that systematic risk for MNEs is greater than that for their
domestic counterparts. This could be due to:
A) the fact that the increase in the correlation of returns between the market and the firm is less
than the increase in the standard deviation of returns of the firm.
B) the fact that the decrease in the correlation of returns between the market and the firm is
greater than the increase in the standard deviation of returns of the firm.
C) the reduction in the correlation of returns between the firm and the market is less than the
increase in the variability of returns caused by factors such as asymmetric information, foreign
exchange risk, and the like.
D) None of the above; systematic risk is less for MNEs than for their domestic counterparts.
Answer: C
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Conceptual
AACSB: Application of knowledge
5) Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms.
This could be due to higher levels of:
A) political risk.
B) exchange rate risk.
C) agency costs.
D) all of the above
Answer: D
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
6) Despite the theoretical elegance of this hypothesis, empirical studies have come to the
opposite conclusion. Despite the favorable effect of international diversification of cash flows,
bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs
faced higher costs for each of the following EXCEPT:
A) agency costs.
B) political risk.
C) asymmetric information.
D) In fact, each of these costs were higher for the MNE than for the domestic firm.
Answer: D
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
7) Empirical studies indicate that WACC for an MNE is higher than for their domestic
competitors. Reasons cited for this increased cost include all of the following EXCEPT:
A) agency costs.
B) foreign exchange risk.
C) political risk.
D) All of the above are cited as reasons for an MNE's increased WACC.
Answer: D
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
8) Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is
significantly lower than that for purely domestic firms.
Answer: FALSE
Diff: 1
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
9) The opportunity set of projects is typically smaller for MNEs than for purely domestic firms
because international markets are typically specialized niches.
Answer: FALSE
Diff: 1
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
10) Surprisingly, empirical studies find that MNEs have a higher level of systematic risk than
their domestic counterparts.
Answer: TRUE
Diff: 1
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
11) Empirical studies indicate that MNEs have a lower debt/capital ratio than domestic
counterparts, indicating that MNEs have a lower cost of capital.
Answer: FALSE
Diff: 2
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Recognition
AACSB: Application of knowledge
12) What do theory and empirical evidence say about capital structure and the cost of capital for
MNEs versus their domestic counterparts?
Answer: In theory, MNEs should be able to support greater amounts of debt due to reduced
variability of cash flows brought about by diversification across countries. And, because of this
reduced risk borne by MNEs, they should also have a lower cost of capital. However, empirical
research finds that domestic firms tend to use greater amounts of short and intermediate debt
than do MNEs and that the cost of capital is greater for MNEs due to increased agency costs,
political risk, exchange rate risk, and asymmetric information.
Diff: 3
L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 14 Funding the Multinational Firm
14.1 Designing a Strategy to Source Capital Globally
1) The choice of when and how to source capital globally is usually aided early on by the advice
of:
A) an investment banker.
B) your stock broker.
C) a commercial banker.
D) an underwriter.
Answer: A
Diff: 1
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Recognition
AACSB: Application of knowledge
2) Investment banking services include which of the following?
A) advising when a security should be cross-listed
B) preparation of stock prospectuses
C) help to determine the price of the issue
D) all of the above
Answer: D
Diff: 1
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Conceptual
AACSB: Application of knowledge
3) Which of the following is the typical order of sourcing capital abroad?
A) an international bond issue, then cross-listing the outstanding issues on other exchanges, then
an international bond issue in the target market
B) an international bond issue in the target market, then cross-listing the outstanding issues on
other exchanges, then an international bond issue
C) an international bond issue in less prestigious markets, then an international bond issue in the
target market, and ultimately a eurobond issue
D) cross-listing the outstanding issues on other exchanges, then an international bond issue, then
an international bond issue in the target market
Answer: C
Diff: 2
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Conceptual
AACSB: Application of knowledge
4) Which of the following is the typical first step sourcing capital abroad?
A) an international bond issue placed on a more prestigious foreign market
B) an international bond issue in the eurobond market
C) an international bond issue placed on a less prestigious foreign market
D) issue equity in one of the less prestigious markets to attract the attention of international
investors first
Answer: C
Diff: 2
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Recognition
AACSB: Application of knowledge
5) By cross listing and selling its shares on a foreign stock exchange, a firm typically tries to
accomplish which of the following?
A) improve the liquidity of its existing shares
B) increase its share price
C) increase the firm's visibility
D) all of the above
Answer: D
Diff: 2
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Conceptual
AACSB: Application of knowledge
6) Most firms raise their initial capital in foreign markets.
Answer: FALSE
Diff: 1
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Conceptual
AACSB: Application of knowledge
7) The ultimate step sourcing capital abroad would be to place a directed equity issue in a
prestigious target market or a euroequity issue in global equity markets.
Answer: TRUE
Diff: 1
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Recognition
AACSB: Application of knowledge
8) Sourcing capital abroad usually follows a logic path. List in sequential order three corporate
strategies in internationalizing the cost of capital.
Answer: Most firms raise their initial capital in their own domestic market. Most firms should
start sourcing abroad with an international bond issue. It could be placed on a less prestigious
foreign market. This could be followed by an international bond issue in a target market or in the
eurobond market. The next step might be to cross-list and issue equity in one of the less
prestigious markets in order to attract the attention of international investors. The next step could
be to cross-list shares on a highly liquid prestigious foreign stock exchange such as London
(LSE), NYSE, Euronext, or NASDAQ. The ultimate step sourcing capital abroad could be to
place a directed equity issue in a prestigious target market or a euroequity issue in global equity
markets.
Diff: 2
L.O.: 14.1 Designing a Strategy to Source Capital Globally
Skill: Conceptual
AACSB: Application of knowledge
14.2 Optimal Financial Structure
1) Which financial economists are most closely associated with the financial theory of optimal
capital structure?
A) Modigliani and Miller
B) Fama, Fisher, Jensen, and Roll
C) Black and Scholes
D) Markowitz and Sharpe
Answer: A
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
2) For most firms, the cost of capital decreases to a low point as the firm ________ debt
financing. At some point beyond this optimal level, the cost of capital increases as the amount of
debt ________.
A) decreases; increases
B) decreases; decreases
C) increases; increases
D) increases; decreases
Answer: C
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
3) One of the most important factors in making debt less expensive than equity is:
A) the tax deductibility of depreciation.
B) the tax deductibility of equity.
C) the tax deductibility of dividends.
D) the tax deductibility of interest.
Answer: D
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
4) One of the most important factors in making debt less expensive than equity is:
A) the seniority of equity obligations to debt claims.
B) the tax deductibility of dividends.
C) the tax deductibility of equity.
D) the seniority of debt obligations to equity claims.
Answer: D
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
5) Which of the following is NOT a factor offsetting the tax advantage of debt as a source of
financing?
A) increased agency costs
B) increased probability of financial distress (bankruptcy) due to fixed interest payments
C) alternative tax shields to those supplied by interest payments
D) All of the above offset the tax advantage of debt as a source of financing.
Answer: D
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
6) Most financial theorists believe that the optimal capital structure is a ________ with a debt to
total value ratio somewhere around ________.
A) point; 50%
B) point; 25%
C) range; 30%-60%
D) range; 10%-40%
Answer: C
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
7) Not all firms have the same optimal capital structure. Factors that might influence a firm's
capital structure include:
A) the industry in which it operates.
B) the volatility of its sales and operating income.
C) the collateral value of its assets.
D) all of the above
Answer: D
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
8) MNEs situated in countries with small illiquid and segmented markets are most like:
A) small domestic U.S. firms in that they must rely on internally generated funds and bank
borrowing.
B) large U.S. MNEs in that they are all MNEs and have worldwide markets and sources of
financing.
C) small domestic U.S. firms in that they have a strong niche market in the U.S.
D) None of the above is true.
Answer: A
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
9) Which of the following were NOT identified by the authors as a variable that needs to be
modified in the domestic theory of optimal financial structures to accommodate the case of the
multinational enterprise?
A) financial distress
B) availability of capital
C) diversification of cash flows
D) foreign exchange risk
Answer: A
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
10) In theory, the MNE should support ________ debt ratios than a purely domestic firm because
their cash flows are ________.
A) lower; more stable due to international diversification
B) lower; less stable due to international diversification
C) higher; more stable due to international diversification
D) higher; less stable due to international diversification
Answer: C
Diff: 2
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
11) TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an
Italian fruit plantation and processing plant. If the interest rate is 6.00% per year, how much
interest will they pay in the first year?
A) $6,000
B) $60,000
C) $600,000
D) 60,000
Answer: B
Diff: 3
L.O.: 14.2 Optimal Financial Structure
Skill: Analytical
AACSB: Analytical thinking
12) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro
depreciates against the dollar from $1.40/ at the time the loan was made to $1.35/ at the end of
the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) 74,250
C) $74,250
D) $77,000
Answer: C
Diff: 3
L.O.: 14.2 Optimal Financial Structure
Skill: Analytical
AACSB: Analytical thinking
13) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro
appreciates against the dollar from $1.40/ at the time the loan was made to $1.45/ at the end of
the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) $79,750
C) $77,000
D) $37,931
Answer: B
Diff: 3
L.O.: 14.2 Optimal Financial Structure
Skill: Analytical
AACSB: Analytical thinking
14) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro
appreciates against the dollar from $1.40/ at the time the loan was made to $1.45/ at the end of
the first year, how much interest and principle will TropiKana pay at the end of the first year if
they repay the entire loan plus interest (rounded)?
A) $1,529,750
B) 1,529,750
C) $1,055,000
D) $1,477,000
Answer: A
Diff: 3
L.O.: 14.2 Optimal Financial Structure
Skill: Analytical
AACSB: Analytical thinking
15) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro
depreciates against the dollar from $1.40/ at the time the loan was made to $1.35/ at the end of
the first year, how much interest and principle will TropiKana pay at the end of the first year if
they repay the entire loan plus interest (rounded)?
A) $1,477,000
B) $1,055,000
C) 1,424,250
D) $1,424,250
Answer: D
Diff: 3
L.O.: 14.2 Optimal Financial Structure
Skill: Analytical
AACSB: Analytical thinking
16) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro
appreciates against the dollar from $1.40/ at the time the loan was made to $1.45/ at the end of
the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest
(rounded)?
A) 1.73%
B) 5.50%
C) 10.50%
D) 9.27%
Answer: D
Diff: 3
L.O.: 14.2 Optimal Financial Structure
Skill: Analytical
AACSB: Analytical thinking
17) Financial theory has at last provided us with a single optimal capital structure for domestic
firms.
Answer: FALSE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
18) Financial practice suggests that there is a range for an optimal capital structure for a firm
within an industry rather than a specific optimal ratio of debt to equity.
Answer: TRUE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
19) In part because of access to global markets, MNEs are better able than their domestic
counterparts to maintain their desired debt ratio even when raising new capital.
Answer: TRUE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
20) When a firm borrows in a foreign currency, the effective cost is the foreign interest rate plus
an adjustment for changes in the exchange rate.
Answer: TRUE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
21) The domestic theory of optimal capital structure does not need to be modified for MNEs.
Answer: FALSE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
22) Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly
correlated. The same reasoning is often argued for MNEs diversifying into international markets.
Answer: TRUE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
23) In theory multinational firms are in a better position than domestic firms to support higher
debt ratios.
Answer: TRUE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
24) A significant advantage of borrowing foreign currency-denominated bonds is that the
borrower need not worry about relative changes in the value of the home currency.
Answer: FALSE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
25) For firms to raise capital in international markets, it is more important to adhere to capital
structure ratios similar to those found in the United States and United Kingdom than to those in
the firm's home country.
Answer: TRUE
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Recognition
AACSB: Application of knowledge
26) In theory multinational firms are in a better position than domestic firms to support higher
debt ratios. Provide an argument as to why this could be true and discuss the empirical research
findings about U.S.-based MNEs.
Answer: Access to capital in global markets allows an MNE to lower its cost of equity and debt
compared with most domestic firms. The theoretical possibility exists that multinational firms
are in a better position than domestic firms to support higher debt ratios because their cash flows
are diversified internationally. The probability of a firm's covering fixed charges under varying
conditions in product, financial, and foreign exchange markets should increase if the variability
of its cash flows is minimized. The diversification argument has been challenged by empirical
research findings that MNEs in the United States actually have lower debt ratios than their
domestic counterparts. The agency costs of debt were higher for the MNEs, as were political
risks, foreign exchange risks, and asymmetric information.
Diff: 1
L.O.: 14.2 Optimal Financial Structure
Skill: Conceptual
AACSB: Application of knowledge
14.3 Raising Equity Globally
1) A/An ________ is defined as one that is targeted at investors in a single country and
underwritten in whole or part by investment institutions from that country.
A) SEC rule 144a placement
B) directed public share issue
C) Euroequity public issue
D) strategic alliance
Answer: B
Diff: 2
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
2) The term "euro" as used in the euro equity market implies:
A) the issuers are located in Europe.
B) the investors are located in Europe.
C) both A and B
D) none of the above
Answer: D
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
3) Strategic alliances are normally formed by firms that expect to gain synergies from which of
the following?
A) economies of scale
B) economies of scope
C) complementary marketing
D) all of the above
Answer: D
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Conceptual
AACSB: Application of knowledge
4) A multinational firm that proceeds to raise capital outside of its domestic market is ultimately
in search of an issuance — the IPO or SPO. But often issuances must be preceded by listings, in
which the shares are traded on an exchange and, therefore, in a specific country market. The
listing serves the following purposes EXCEPT:
A) gaining name recognition.
B) reducing the compliance costs.
C) gaining visibility.
D) preparing the market for an issuance.
Answer: B
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
5) The public pathway to raise equity capital outside of its home market includes the following
EXCEPT:
A) Euroequity issue.
B) Strategic Partner/Alliance.
C) shares sold to a specific market or exchange.
D) seasoned offering.
Answer: B
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Conceptual
AACSB: Application of knowledge
6) The initial issuance of shares by a company in an IPO typically represents no more than:
A) 25%.
B) 35%.
C) 45%.
D) 55%.
Answer: A
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
7) Which of the following is a characteristic of an euroequity issue?
A) an initial public offering of euro denominated securities
B) the issuers are located in Europe
C) the investors are located in Europe
D) is an offering on multiple exchanges in multiple countries at the same time
Answer: D
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
8) Which of the following high profile euroequity issues was NOT also a privatization?
A) British Telecommunications
B) Gucci
C) YPF Sociedad Anónima
D) Telefonos de Mexico
Answer: B
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
9) Once a firm has "gone public," it is open to a considerably higher level of public scrutiny.
Answer: TRUE
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
10) A distinction about the publicly traded firm's shares is that they raise capital with the daily
rise and fall of their share prices.
Answer: TRUE
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
11) A euroequity issue is an initial public offering of euro denominated securities.
Answer: FALSE
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Recognition
AACSB: Application of knowledge
12) List and discuss three public pathway strategies for a MNE for raising equity capital outside
its home market.
Answer: A euroequity or euroequity issue is an initial public offering on multiple exchanges in
multiple countries at the same time. A directed public share issue or directed issue is defined as
one that is targeted at investors in a single country and underwritten in whole or in part by
investment institutions from that country. Depositary receipts (DRs) are negotiable certificates
issued by a bank to represent the underlying shares of stock that are held in trust at a foreign
custodian bank.
Diff: 1
L.O.: 14.3 Raising Equity Globally
Skill: Conceptual
AACSB: Application of knowledge
14.4 Depositary Receipts
1) ________ are negotiable certificates issued by a bank to represent the underlying shares of
stock, which are held in trust at a foreign custodian bank.
A) Negotiable CDs
B) International mutual funds
C) Depositary receipts
D) Eurodeposits
Answer: C
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
2) Depositary receipts traded outside the United States are called ________ depositary receipts.
A) Euro
B) Global
C) American
D) none of the above
Answer: B
Diff: 1
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
3) Each ADR represents ________ of the shares of the underlying foreign stock.
A) a multiple
B) 100
C) 1
D) ADRs have nothing to do with foreign stocks.
Answer: A
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT an advantage of ADRs to U.S. shareholders?
A) Transfer of ownership is done in the U.S. in accordance with U.S. laws.
B) In the event of the death of the shareholder, the estate does not go through a foreign court.
C) Settlement for trading is generally faster in the United States.
D) All of the above are advantages of ADRs.
Answer: D
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
5) ADRs that are created at the request of a foreign firm wanting its shares traded in the United
States are:
A) facilitated.
B) unfacilitated.
C) sponsored.
D) unsponsored.
Answer: C
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
6) Who pays the costs of creating a sponsored ADR?
A) the foreign firm whose stocks underlie the ADR
B) the U.S. bank creating the ADR
C) both the U.S. bank and the foreign firm
D) the SEC since they require the regulation
Answer: A
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
7) Level I ADRs trade primarily:
A) on the New York Stock Exchange.
B) on the American Stock Exchange.
C) over the counter or pink sheets.
D) Level I ADRs typically do not trade at all, but instead are privately issued and held until
maturity.
Answer: C
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
8) Level II ADRs must meet:
A) U.S. GAAP standards.
B) home country accounting standards.
C) both U.S. GAAP and home country standards.
D) none of the above
Answer: A
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Conceptual
AACSB: Application of knowledge
9) Level ________ is the easiest standard to satisfy for issuing ADRs.
A) 144a
B) III
C) II
D) I
Answer: D
Diff: 1
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
10) Level III ADR commitment applies to:
A) firms that want to list existing shares on the NYSE.
B) banks issuing foreign mutual funds.
C) ADR issues of under $25,000.
D) the sale of a new equity issued in the United States.
Answer: D
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
11) ADRs cannot be exchanged for the underlying shares of the foreign stock, therefore,
arbitrage cannot keep the prices in line with the foreign price of the stock.
Answer: FALSE
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Conceptual
AACSB: Application of knowledge
12) An unsponsored ADR may be initiated without the approval of the foreign firm with the
underlying stock.
Answer: FALSE
Diff: 1
L.O.: 14.4 Depositary Receipts
Skill: Recognition
AACSB: Application of knowledge
13) ADRs are considered an effective way for firms to improve the liquidity of their stock,
especially if the home market is small and illiquid.
Answer: TRUE
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Conceptual
AACSB: Application of knowledge
14) Depositary Receipts intra-market trades account for more than 90% of all DR trading today.
Answer: TRUE
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Conceptual
AACSB: Application of knowledge
15) One of the benefits of investing in Global Registered Shares (GRS) is that GRS allow to
invest in foreign companies without foreign exchange risk.
Answer: FALSE
Diff: 2
L.O.: 14.4 Depositary Receipts
Skill: Conceptual
AACSB: Application of knowledge
16) ADRs are a popular investment tool for many U.S. investors. In recent years several
alternatives for investing in foreign equity securities have become available for U.S. investors,
yet ADRs remain popular. Define what an ADR is and provide at least three examples of the
advantages they may hold over alternative foreign investment vehicles for U.S. investors.
Answer: Depositary receipts are negotiable certificates issued by a bank to represent the
underlying shares of stock held in trust at a foreign custodian bank. Those receipts traded in the
U.S. and denominated in dollars are called American depositary receipts (ADR). Because ADRs
can be exchanged for the underlying foreign security, arbitrage keeps the prices in line. Even
though U.S. investors can invest directly into some foreign equity markets, ADRs do offer some
technical advantages. Among those advantages are that dividends are received in dollars rather
than a foreign currency, ADRs are in registered form rather than bearer form, transfer of
ownership is done in accordance with U.S. laws, and in the event of death, probate is in the U.S.
and not abroad. Taxes are easier, trading costs are typically lower, and settlement is also faster.
Diff: 3
L.O.: 14.4 Depositary Receipts
Skill: Conceptual
AACSB: Application of knowledge
17) List and describe three differences and advantages of Global Registered Shares (GRS) over
American Depositary Receipts (ADRs).
Answer: Depositary receipts are negotiable certificates issued by a bank to represent the
underlying shares of stock held in trust at a foreign custodian bank. Those receipts traded in the
U.S. and denominated in dollars are called American depositary receipts (ADR). ADRs do offer
some technical advantages: dividends are received in dollars rather than a foreign currency,
ADRs are in registered form rather than bearer form, transfer of ownership is done in accordance
with U.S. laws, and in the event of death, probate is in the U.S. and not abroad. Taxes are easier,
trading costs are typically lower, and settlement is also faster.
A global registered share (GRS) is a share of equity that is traded across borders and markets
without conversion, where one share on the home exchange equals one share on the foreign
exchange. If target pricing is important in key markets like that of the U.S., then the ADR offers
better opportunities for a foreign firm to gain greater presence and activity. There are two
fundamental arguments in favor of GRSs over ADRs, both based on pure forces of
globalization:1) Investors and markets alike will continue to grow, 2) Regulations governing
security trading across country markets will continue to converge towards a common set of
global principles, eliminating the need for securities customized for local market attributes or
requirements. Other potential distinctions include the possibility of retaining all voting rights
(GRSs do by definition while some ADRs may not) and the general principle that ADRs are
designed for one singular cultural and legal environment—the United States.
Diff: 3
L.O.: 14.4 Depositary Receipts
Skill: Conceptual
AACSB: Application of knowledge
14.5 Private Placement
1) Which of the following was NOT identified by the authors as an alternative instrument to
source equity in global markets?
A) sale of a directed public share issue to investors in a target market
B) private placements under SEC rule 144a
C) sale of shares to private equity funds
D) All of the above are alternatives to source equity instruments.
Answer: D
Diff: 2
L.O.: 14.5 Private Placement
Skill: Recognition
AACSB: Application of knowledge
2) Private equity funds (PEF) differ from traditional venture capital (VC) funds in that:
A) VC operates mainly in lesser-developed countries while PEF do not.
B) VC typically invests in family business whereas PEF do not.
C) VC is almost unavailable to emerging markets while PEF capital is available.
D) All of the above are true.
Answer: C
Diff: 2
L.O.: 14.5 Private Placement
Skill: Conceptual
AACSB: Application of knowledge
3) By cross-listing shares on a foreign exchange, you can expect:
A) no share price effect for foreign firms that cross-list on major U.S. exchanges.
B) a positive share price effect for foreign firms that cross-list on major U.S. exchanges.
C) a negative share price effect for foreign firms that cross-list on major U.S. exchanges.
D) none of the above
Answer: B
Diff: 2
L.O.: 14.5 Private Placement
Skill: Recognition
AACSB: Application of knowledge
4) In addition to gaining liquidity, which of the following could also be considered a legitimate
reason for cross-listing equity?
A) enhance a firm's local image
B) become more familiar with the local financial community
C) get better local press coverage
D) all of the above
Answer: D
Diff: 2
L.O.: 14.5 Private Placement
Skill: Conceptual
AACSB: Application of knowledge
5) The worldwide trend toward fuller and more standardized disclosure rules should ________
the cost of equity capital.
A) increase
B) decrease
C) have no impact on
D) none of the above
Answer: B
Diff: 2
L.O.: 14.5 Private Placement
Skill: Recognition
AACSB: Application of knowledge
6) SEC rule 144A permits institutional buyers to trade privately placed securities without the
previous holding periods restrictions and without requiring SEC registration.
Answer: TRUE
Diff: 1
L.O.: 14.5 Private Placement
Skill: Recognition
AACSB: Application of knowledge
7) Private equity funds are best known for buying control of private owned firms, taking them
publicly, improving management, and then reselling them after one to three years.
Answer: FALSE
Diff: 1
L.O.: 14.5 Private Placement
Skill: Recognition
AACSB: Application of knowledge
8) Private equity funds appear to have a longer time horizon than traditional venture capital
funds.
Answer: TRUE
Diff: 1
L.O.: 14.5 Private Placement
Skill: Recognition
AACSB: Application of knowledge
9) The least liquid stock markets offer little liquidity for their own domestic firms, and are of
little value to foreign firms.
Answer: TRUE
Diff: 1
L.O.: 14.5 Private Placement
Skill: Conceptual
AACSB: Application of knowledge
10) Private equity funds differ from traditional venture capital funds. List and discuss three
differences between them.
Answer: Private equity funds differ from traditional venture capital funds. VC funds usually
1) operate mainly in highly developed countries, 2) invest in start-up firms with the goal of
exiting the investment with an IPO placed in those same highly liquid markets, 3) very little VC
is available in emerging markets, partly because it would be difficult to exit with an IPO in an
illiquid market. The same exiting problem faces the private equity funds, but they appear to have
a longer time horizon, 4) VC funds appear to have a shorter time horizon, 5) Private equity funds
invest in already mature and profitable companies, 6) Private equity funds are content with
growing companies through better management and mergers with other firms.
Diff: 3
L.O.: 14.5 Private Placement
Skill: Conceptual
AACSB: Application of knowledge
14.6 Raising Debt Globally
1) ________ are domestic currencies of one country on deposit in a second country.
A) LIBORs
B) Eurocurrencies
C) Federal funds
D) Discount window deposits
Answer: B
Diff: 1
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
2) Of the following, which was NOT cited by the authors as a valuable function provided by the
Eurocurrency market?
A) Eurocurrency deposits are an efficient and convenient money market device for holding
excess corporate liquidity.
B) Eurocurrency deposits are a tool used by the Federal Reserve to regulate the money supply of
countries that peg their currency against the U.S. dollar.
C) The Eurocurrency market is a major source of short-term bank loans to finance corporate
working capital needs.
D) All of the above were cited by the authors.
Answer: B
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
3) Eurobanks are:
A) banks where Eurocurrencies are deposited.
B) major world banks that conduct a Eurocurrency business in addition to normal banking
activities.
C) financial intermediaries that simultaneously bid for time deposits in and make loans in a
currency other than that of the currency of where it is located.
D) All of the above are descriptions of a Eurobank.
Answer: D
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
4) Eurocredits are:
A) bank loans to MNEs and others denominated in a currency other than that of the country
where the bank is located.
B) typically variable rate and tied to the LIBOR.
C) usually for maturities of six months or less.
D) All of the above are true.
Answer: D
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Conceptual
AACSB: Application of knowledge
5) In general, which has the shorter maturity and is more appropriate for funding short-term
inventory needs?
A) commercial paper
B) Euro-Medium-Term notes (EMTNs)
C) the international bond market
D) all of the above
Answer: A
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
6) Foreign bonds sold in the United States are nicknamed "Yankee bonds," foreign bonds sold in
Japan are called "Samurai bonds." What are foreign bonds sold in the United Kingdom
nicknamed?
A) "Union Jacks"
B) "Royalty"
C) "Bulldogs"
D) "Churchill's"
Answer: C
Diff: 1
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
7) A ________ is a bond underwritten by a syndicate from a single country, sold within in that
country, denominated in that country's currency, but the issuer is from outside that country.
A) foreign bond
B) Eurobond
C) domestic bond
D) none of the above
Answer: A
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
8) The eurobond market owes its existence to all of the following reasons unique factors
EXCEPT:
A) free bond ratings.
B) the absence of regulatory interference.
C) less stringent disclosure practices.
D) favorable tax treatment.
Answer: A
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
9) Eurocurrencies are NOT the same as the euro developed for the common European currency.
Answer: TRUE
Diff: 1
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
10) The Eurocurrency market continues to thrive because it is a large international money market
relatively free of governmental regulation and interference.
Answer: TRUE
Diff: 1
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
11) Moody's rates international bonds at the request of the issuer with the stipulation that
Moody's will publish the ratings even if the ratings are unfavorable.
Answer: FALSE
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
12) Eurobonds offer tax anonymity.
Answer: TRUE
Diff: 2
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
13) Eurobonds are usually issued in registered form.
Answer: FALSE
Diff: 1
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
14) Moody's assesses the investor's risk caused by changing exchange rates in the investment.
Answer: FALSE
Diff: 1
L.O.: 14.6 Raising Debt Globally
Skill: Recognition
AACSB: Application of knowledge
15) The Euro-medium-term-note (EMTN) has filled a substantial niche market in global
financing. What are the distinguishing characteristics of the EMTN and why is it such a popular
form of financing for MNEs?
Answer: EMTNs have maturity between the long-lived international bonds and the short-term
Euro-commercial paper, thus they have an appealing time horizon to many investors. EMTNs are
like international bonds in that they pay periodic interest. The distinguishing features of an
EMTN are: They are similar to a shelf registration in that the entire order for the securities does
not have to be issued on the same day. Coupon payments are paid continuously, and the
relatively small denominations allow for some flexibility in the market.
Diff: 3
L.O.: 14.6 Raising Debt Globally
Skill: Conceptual
AACSB: Application of knowledge
14.7 Financing Foreign Subsidiaries
1) External sources of financing available for foreign subsidiaries include all of the following
EXCEPT:
A) debt from the parent's country.
B) debt from countries outside the parent's country.
C) local or global equity.
D) intercompany and intracompany loans.
Answer: D
Diff: 2
L.O.: 14.7 Financing Foreign Subsidiaries
Skill: Recognition
AACSB: Application of knowledge
2) The financial structure and financing of a foreign subsidiary change over time as it passes
through the following stages of its business life cycle EXCEPT:
A) maturing.
B) growth.
C) startup.
D) discovery.
Answer: D
Diff: 2
L.O.: 14.7 Financing Foreign Subsidiaries
Skill: Recognition
AACSB: Application of knowledge
3) Internal financing includes all potential sources of fund arising from the MNE itself.
Answer: TRUE
Diff: 1
L.O.: 14.7 Financing Foreign Subsidiaries
Skill: Recognition
AACSB: Application of knowledge
4) External financing includes debt from any source that is not the MNE itself and equity from
any potential partner.
Answer: TRUE
Diff: 1
L.O.: 14.7 Financing Foreign Subsidiaries
Skill: Recognition
AACSB: Application of knowledge
5) In early stages of a foreign subsidiary's life, local host country debt is the only possible source
of funding.
Answer: FALSE
Diff: 1
L.O.: 14.7 Financing Foreign Subsidiaries
Skill: Recognition
AACSB: Application of knowledge
6) Multinationals often strive to maximize the amount of equity from the parent company in
foreign subsidiaries in order to reduce capital risk.
Answer: FALSE
Diff: 1
L.O.: 14.7 Financing Foreign Subsidiaries
Skill: Recognition
AACSB: Application of knowledge
7) Host country government would, in the extreme, prefer all inward investment be financed with
local debt.
Answer: FALSE
Diff: 1
L.O.: 14.7 Financing Foreign Subsidiaries
Skill: Recognition
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 15 Multinational Tax Management
15.1 Tax Principles and Practices
1) The issue of ethics in the reporting of income and the payment of taxes is a considerable one.
The authors state that most MNEs operating in foreign countries tend to follow the general
principle of:
A) "when in Rome, do as the Romans do."
B) full disclosure to the tax authorities.
C) maintain a competitive playing field by cheating as much as the local competition, no more,
no less.
D) none of the above
Answer: B
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
2) Which of the following is an unlikely objective of U.S. government policy for the taxation of
foreign MNEs?
A) to raise revenues
B) to provide an incentive for U.S. private investment in developing countries
C) to improve the U.S. balance of payments
D) All of the above are objectives.
Answer: D
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
3) A ________ tax policy is one that has no impact on private decision-making, while a
________ policy is designed to encourage specific behavior.
A) flat; tax incentive
B) neutral; flat tax
C) neutral; tax incentive
D) none of the above
Answer: C
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
4) Which of the following is NOT an example of a tax incentive policy?
A) The federal government gives a tax credit to MNEs that make domestic capital improvements
but not foreign capital improvements.
B) Corporations are allowed to take a direct tax credit for each dollar of matching donations they
make to institutions of higher education.
C) A tax law is passed that makes interest on property non-tax-deductible, but interest payments
on durable goods are.
D) All are examples of a tax incentive policy.
Answer: D
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
5) Toyota Motor Company operates in many different countries and pays taxes at many different
rates. However, they always pay the same rate as their local competitors. Toyota Motor
Company is operating in an environment of ________ tax policy.
A) domestic neutrality
B) foreign neutrality
C) territorial approach
D) none of the above
Answer: B
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
6) The United States taxes the domestic and remitted foreign earnings of U.S. based MNEs no
matter where the earnings occurred. This is an example of a/an ________ approach to levying
taxes.
A) worldwide
B) territorial
C) neutral
D) equitable
Answer: A
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
7) The United States taxes all earnings on U.S. soil by both domestic and foreign firms. This is
an example of a ________ approach to levying taxes.
A) worldwide
B) neutral
C) territorial
D) none of the above
Answer: C
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
8) Bacon Signs Inc. is based in a country with a territorial approach to taxation but generates
100% of its income in a country with a worldwide approach to taxation. The tax rate in the
country of incorporation is 25%, and the tax rate in the country where they earn their income is
50%. In theory, and barring any special provisions in the tax codes of either country, Bacon
should pay taxes at a rate of ________ in the country of incorporation.
A) 75%.
B) 62.5%.
C) 0%.
D) 50%.
Answer: C
Diff: 3
L.O.: 15.1 Tax Principles and Practices
Skill: Analytical
AACSB: Analytical thinking
9) The territorial approach to taxation policy is also termed the ________ approach.
A) source
B) ethical
C) greedy
D) location
Answer: A
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
10) A tax that is effectively a sales tax at each stage of production is defined as a/an ________
tax.
A) flat
B) equitable
C) value-added tax
D) none of the above
Answer: C
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
11) What is the total value of taxes paid in the following example if the value added tax is 10%?
A farmer raises wheat that he sells for $1.50 to the grain company. The grain company sells to
the processor for $2.00 per bushel. The processor turns the wheat into a breakfast cereal and
wholesales it for $3.00 per bushel. The retailer sells the cereal for $4.00 per bushel.
A) $0.15
B) $0.20
C) $0.30
D) $0.40
Answer: D
Diff: 3
L.O.: 15.1 Tax Principles and Practices
Skill: Analytical
AACSB: Analytical thinking
12) A tax that is a form of social redistribution of income is defined as a/an ________ tax.
A) un-American
B) transfer
C) flat
D) none of the above
Answer: B
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
13) Tax treaties typically result in ________ between the two countries in question.
A) lower property taxes for U.S. citizens overseas
B) elimination of differential tax rates
C) increased double taxation
D) reduced withholding tax rates
Answer: D
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
14) The primary objective of multinational tax planning is to minimize the firm's worldwide tax
burden.
Answer: TRUE
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
15) A country CANNOT have both a territorial and a worldwide approach as a national tax
policy.
Answer: FALSE
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
16) Tax treaties generally have the effect of increasing the withholding taxes between the
countries that are negotiating the treaties.
Answer: FALSE
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
17) A value-added tax has gained widespread usage in Western Europe, Canada, and parts of
Latin America.
Answer: TRUE
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
18) All indications are that the value-added tax will soon be the dominant form of taxation in the
U.S.
Answer: FALSE
Diff: 1
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
19) Among the G7 nations, the U.S. has a below average corporate income tax rate that makes it
attractive for other countries to invest in the U.S.
Answer: FALSE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
20) In the mid-1980s, the U.S. led the way to higher corporate income tax rates worldwide.
Today, most of the G7 nations have surpassed the U.S. and have higher corporate income tax
rates than the U.S.
Answer: FALSE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
21) The ideal tax should not only raise revenue efficiently but also have as few negative effects
on economic behavior as possible.
Answer: TRUE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
22) The worldwide approach, also referred to as the residential or national approach to tax
policy, levies taxes on the income earned by firms that are incorporated in the host country,
regardless of where the income was earned (domestically or abroad).
Answer: TRUE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
23) The territorial approach, also referred to as the source approach to tax policy, levies taxes on
the income earned by firms that are incorporated in the host country, regardless of where the
income was earned (domestically or abroad).
Answer: FALSE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
24) Of the OECD 30 countries, most employ a worldwide approach to tax policy, but a few,
including the United States, use the worldwide approach.
Answer: TRUE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
25) FEW governments rely on income taxes, both personal and corporate, for their primary
revenue source.
Answer: FALSE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
26) Between 2006-2012, global corporate tax rates have trended upward.
Answer: FALSE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
27) Tax treaties typically result in reduced withholding tax rates between the two signatory
countries.
Answer: TRUE
Diff: 2
L.O.: 15.1 Tax Principles and Practices
Skill: Recognition
AACSB: Application of knowledge
28) Explain the worldwide and territorial approaches of national taxation. The authors state that
the United States uses both approaches. How can this be? Give an example of each taxation
approach.
Answer: The worldwide approach taxes the income of firms based on their place of residence
rather than on where the income was earned. Thus, a U.S. based MNE will owe U.S. taxes on
income earned in, say, Britain. The territorial approach to taxation taxes all of the income earned
within the borders of the country by both domestic and foreign-based firms. Thus, a British-
based firm making sales in New York will owe taxes in the U.S.
Through a series of bilateral tax agreements, the U.S. and several trading partners have tried to
workout tax issues. Generally, the taxes a U.S. based MNE pays abroad will help offset any
required taxes the firm might have on funds remitted to the United States.
Diff: 3
L.O.: 15.1 Tax Principles and Practices
Skill: Analytical
AACSB: Analytical thinking
29) What is a value-added tax? Where is this type of tax in wide usage? Why do you suppose
this form of taxation has NOT been widely accepted in the United States?
Answer: A value-added tax (VAT) is a form of national sales tax, where goods are taxed at each
step of extraction, production, wholesale, and retail. A VAT tax is considered regressive because
those with lower incomes pay the same taxes on a particular commodity as those with more
money. Americans have never taken to this type of national tax because the most similar type of
state and local tax is the sales tax, and that has always been the domain of the states. Plus the fact
that it is regressive make the tax a tough sell to taxpayers.
Diff: 3
L.O.: 15.1 Tax Principles and Practices
Skill: Conceptual
AACSB: Application of knowledge
15.2 Multinational Tax Management
TABLE 15.1
Use the information to answer following question(s).
BayArea Designs Inc., located in Northern California, has two international subsidiaries, one
located in the Ukraine, the other in Korea. Consider the information below to answer the next
several questions.
1) Refer to Table 15.1. If BayArea pays out 50% of its earnings from each subsidiary, what are
the additional U.S. taxes due on the foreign sourced income from the Ukraine and Korea
respectively?
A) Ukraine = $0; Korea = ($30,000)
B) Ukraine = $100,000; Korea = $0
C) Ukraine = $0; Korea = $66,250
D) none of the above
Answer: D
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
2) Refer to Table 15.1. The additional U.S. taxes due on the repatriation of income from the
Ukraine to the United States, alone, assuming a 50% payout rate, is:
A) excess foreign tax credits of $110,000.
B) additional U.S. taxes due of $97,000.
C) additional U.S. taxes due of $36,500.
D) excess foreign tax credits of $18,500.
Answer: A
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
3) Refer to Table 15.1. How much in additional U.S. taxes would be due if BayArea averaged
the tax credits and liabilities of the two foreign units, assuming a 50% payout rate from each?
A) $3,750
B) $13,750
C) $2,500
D) $0
Answer: C
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
4) Refer to Table 15.1. If BayArea set the payout rate from the Ukraine subsidiary at 25%, how
should BayArea set the payout rate of the Korean subsidiary (approximately) to more efficiently
manage its total foreign tax bill?
A) 28.5%
B) 24.5%
C) 42.6%
D) 82.3%
Answer: B
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
5) Refer to Table 15.1. What is the minimum effective tax rate that BayArea can achieve on its
foreign-sourced income?
A) 26%
B) 35%
C) 40%
D) 0%
Answer: B
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
6) A ________ is a direct reduction of taxes whereas a ________ reduces the taxable income
before taxes.
A) foreign tax credit; domestic tax credit
B) tax deduction; tax credit
C) tax credit; tax deduction
D) none of the above
Answer: C
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
Instruction 15.2:
Use the information to answer the following question(s).
Green Valley Exporters USA has $100,000 of before-tax foreign income. The host country has a
corporate income tax rate of 25% and the U.S. has a corporate income tax rate of 35%.
7) Refer to Instruction 15.2. If the U.S. has no bilateral trade agreement with the host country,
what is the total amount of income taxes Green Valley Exporters will pay?
A) $25,000
B) $35,000
C) $51,250
D) $60,000
Answer: C
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
8) Refer to Instruction 15.2. If the U.S. has a bilateral trade agreement with the host country that
calls for the total tax paid to be equal to the maximum amount that could be paid in the highest
taxing country, what is the total amount of income taxes Green Valley Exporters will pay to the
host country, and how much will they pay in U.S income taxes on the foreign earned income?
A) $25,000; $10,000
B) $25,000; $26,250
C) $35,000; $0
D) none of the above
Answer: A
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
9) Refer to Instruction 15.2. If the U.S. treated the taxes paid on income earned in the host
country as a tax-deductible expense, then Green Valley's total U.S. corporate tax on the foreign
earnings would be:
A) $10,000.
B) $26,250.
C) $35,000.
D) $51,250.
Answer: B
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
10) Refer to Instruction 15.2. If the U.S. treated the taxes paid on income earned in the host
country as a tax-credit, then Green Valley's total U.S. corporate tax on the foreign earnings
would be:
A) $51,250.
B) $35,000.
C) $26,250.
D) $10,000.
Answer: D
Diff: 3
L.O.: 15.2 Multinational Tax Management
Skill: Analytical
AACSB: Analytical thinking
11) Transfer pricing is a strategy that may be used by MNEs to:
A) reduce consolidated corporate income taxes.
B) partially finance a subsidiary in another country.
C) transfer funds from a subsidiary to the parent corporation.
D) all of the above
Answer: D
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
12) ________ is the pricing of goods, services, and technology between related companies.
A) Among pricing
B) Retail pricing
C) Transfer pricing
D) Wholesale pricing
Answer: C
Diff: 1
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
13) Tax-haven subsidiaries are typically established in a country that can meet the following
requirements:
A) a low tax on foreign investment or sales income earned by resident corporations and a low
dividend withholding tax on dividends paid to the parent firm.
B) the facilities to support financial services, for example, good communications, professional
qualified office workers, and reputable banking services.
C) a stable government that encourages the establishment of foreign-owned financial and service
facilities within its borders.
D) all of the above
Answer: D
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
14) The rapid evolution of corporate inversions for U.S.-based multinationals over the past 20
years has been attributed to all of the following EXCEPT:
A) lack of foreign tax credits.
B) relatively high U.S. corporate tax rate.
C) U.S. lack of global competitiveness.
D) the worldwide tax principles.
Answer: A
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
15) Of the following, which is NOT cited by the authors as an example of tax haven?
A) Ireland
B) Bermuda
C) Cayman Islands
D) Bahamas
Answer: A
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
16) Tax credits are less valuable on a dollar-for-dollar basis than are tax-deductible expenses.
Answer: FALSE
Diff: 1
L.O.: 15.2 Multinational Tax Management
Skill: Conceptual
AACSB: Application of knowledge
17) The U.S. Internal Revenue Service can reallocate revenues and expenses between parent
corporations and their subsidiaries to more clearly reflect a proper allocation of income. In such
instances it is the responsibility of the corporation to prove that the IRS has been arbitrary in its
decision-making, thus establishing a "guilty until proved innocent" tax approach.
Answer: TRUE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
18) When a firm is organized with decentralized profit centers, transfer pricing between centers
can help in the evaluation of each subsidiary performance.
Answer: FALSE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
19) If a U.S. multinational remits profits from two different countries (subsidiaries) back to the
parent company (U.S.), the excess foreign tax credit from one subsidiary can only be cross-
credited against another subsidiary from the same country.
Answer: FALSE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
20) Tax haven subsidiaries of MNEs are categorically referred to as international offshore
financial centers.
Answer: TRUE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
21) Maximizing local profits in joint ventures overseas could be suboptimal from the overall
view of the MNE.
Answer: TRUE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
22) In a typical naked corporate inversion transaction, the corporation's effective global tax
liability is reduced, but the effective control does not change.
Answer: TRUE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
23) The 80% rule added in the American Jobs Creation Act (AJCA) of 2004 makes less likely
that the former parent company would continue to be treated as domestic.
Answer: FALSE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
24) One case of inversion is when a U.S. company is merged with a large foreign firm and the
new combined entity is incorporated in the foreign country. The added stipulation to be a valid
inversion is that the previous U.S. ownership must have a position of less than 80% ownership in
the new combined entity.
Answer: FALSE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
25) Finance ministers of the G20 in conjunction with the OECD created an action plan to stop
basis erosion and profit shifting (BEPS) in an effort to stop illegal activity.
Answer: FALSE
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Recognition
AACSB: Application of knowledge
26) What is a transfer price, and can a government regulate it? What difficulties and motives
does a parent multinational firm face in setting transfer prices?
Answer: A transfer price is the amount paid by one unit of a company (domestic or
international) for goods or services purchased from another unit of the same firm. As such, a
transfer price is needed for every intrafirm transaction. Where buyer and seller are in different
tax jurisdictions (i.e., countries), governments are concerned with the possibility that transfer
prices are raised or lowered from a "normal" or "appropriate" level in order to avoid taxes. In
most countries tax authorities have the right to declare a given international transfer price as a tax
avoidance device. Such countries have the right to reset taxable income to a higher level. The
motives for the parent MNE are to minimize taxes, and the difficulty is that the burden of proof
is on the MNE, not the tax collector, to show proof as to why a given transfer price is reasonable.
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Conceptual
AACSB: Application of knowledge
27) What are the desired characteristics for a country if it expects to be used as a tax haven?
Answer: Tax-haven subsidiaries are typically established in a country that can meet the
following requirements: 1) A low tax on foreign investment or sales income earned by resident
corporations and a low dividend withholding tax on dividends paid to the parent firm. 2) A stable
currency to permit easy conversion of funds into and out of the local currency. 3) The facilities to
support financial services: good communications, professional qualified office workers, and
reputable banking services. 4) A stable government that encourages the establishment of foreign-
owned financial and service facilities within its borders.
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Conceptual
AACSB: Application of knowledge
28) Why do the U.S. tax authorities tax passive income generated offshore differently from
active income?
Answer: One type of passive income would simply be the distributed profits of another
company, dividends, if the foreign company owned it. Without the differential treatment, it
would only make sense for most U.S. multinationals to create a holding company in a tax haven,
which would then own all the foreign subsidiaries of the company. Then, all the profits earned by
the Holding Company would be retained in a low tax environment without incurring any U.S. tax
liabilities.
Diff: 2
L.O.: 15.2 Multinational Tax Management
Skill: Conceptual
AACSB: Application of knowledge
15.3 Google: An Illustrative Case of Profit Repositioning
1) Why is it core to Google's tax planning to fix a tax base (also known as permanent
establishment) in Ireland?
Answer: Permanent establishment rules allow firms such as Google to fix a tax base in a low-
tax country like Ireland, while generating lots of business in a country where tax rates are higher,
like France. Companies in principle are taxed not on "where they do business," but on "where
they finalize their business deals with customers" —the country or jurisdiction where the final
contract is signed. In the case of Google, that means most sales throughout the European Union
are finalized in Ireland. It is estimated that 75% of the top 50 U.S. software, Internet, and
computer hardware companies use similar PE structures that help them avoid taxes.
Diff: 2
L.O.: 15.3 Google: An Illustrative Case of Profit Repositioning
Skill: Conceptual
AACSB: Application of knowledge
15.4 Global Tax Competitiveness
1) The changing global tax environment for multinational firms has been attributed to all of the
following EXCEPT:
A) rapid expansion of the global digital economy.
B) aggressiveness of governments to increase their individual tax competitiveness.
C) increase cost of capital.
D) all of the above
Answer: C
Diff: 2
L.O.: 15.4 Global Tax Competitiveness
Skill: Conceptual
AACSB: Application of knowledge
2) Governments worldwide compete for global investment on all of the following grounds
EXCEPT:
A) availability of skilled labor.
B) labor cost.
C) regulatory requirements.
D) all of the above
Answer: D
Diff: 2
L.O.: 15.4 Global Tax Competitiveness
Skill: Conceptual
AACSB: Application of knowledge
3) In the context of the digital economy many tax authorities are redefining the location of a
taxable transaction from the county of the supplier to the country of the buyer.
Answer: TRUE
Diff: 1
L.O.: 15.4 Global Tax Competitiveness
Skill: Recognition
AACSB: Application of knowledge
4) All the OECD countries depend on individual income taxes for a very large part of their tax
proceeds.
Answer: FALSE
Diff: 1
L.O.: 15.4 Global Tax Competitiveness
Skill: Recognition
AACSB: Application of knowledge
5) Tax analysts and authorities believe that in the years ahead most of the world will move
towards increased use of direct taxes — income taxes.
Answer: FALSE
Diff: 1
L.O.: 15.4 Global Tax Competitiveness
Skill: Recognition
AACSB: Application of knowledge
15.5 U.S. Tax Law Change in 2017
1) The Act of 2017 has multiple provisions; the following are likely of the most significant to all
U.S. companies EXCEPT:
A) U.S. corporate income tax rate is reduced to 21%.
B) Limits the net interest deductions.
C) Allows companies to deduct the entire cost of equipment purchases from their taxable
income.
D) all of the above
Answer: D
Diff: 2
L.O.: 15.5 U.S. Tax Law Change in 2017
Skill: Conceptual
AACSB: Application of knowledge
2) As part of the Act of 2017, the taxation of Foreign-Source Income will not create tax credits
or deficits when declared as dividends to the U.S. parent.
Answer: TRUE
Diff: 1
L.O.: 15.5 U.S. Tax Law Change in 2017
Skill: Recognition
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 16 International Trade Finance
16.1 The Trade Relationship
1) The exporter-importer relationship to a corporation of a foreign importer that has not
previously conducted business with the firm would be an:
A) unaffiliated known.
B) affiliated party.
C) unaffiliated unknown.
D) any of the above
Answer: C
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following relationships between importing and exporting parties would require
the least detailed contract to conduct business?
A) affiliated party
B) unaffiliated unknown party
C) known unaffiliated party
D) domestic supplier
Answer: B
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
3) Polaris Corporation has made an agreement to ship goods to a foreign firm with whom they
have not entered into a contract for three years. However, the firms have communicated regularly
since the last sale three years ago. This is an example of an:
A) unaffiliated known party transaction.
B) unaffiliated unknown party transaction.
C) affiliated party transaction.
D) none of the above
Answer: A
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Conceptual
AACSB: Application of knowledge
4) Which of the following is NOT a financial instrument that may be included in an international
trade transaction?
A) Letter of Credit
B) Sight Draft
C) Order bill of lading
D) Federal funds transaction
Answer: D
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
5) The combination of a letter of credit, a sight draft, and an order bill of lading protect both
parties in international transactions from which of the following?
A) the risk of noncompletion
B) the risk of foreign exchange risk (when combined with a various hedging techniques)
C) the risk that financing will not be available due to foreign exchange risk
D) All of these risks are reduced when using these trade implements.
Answer: D
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
6) The risk of noncompletion is most important:
A) when the international trade is recurrent in nature.
B) when there is a sustained relationship between the buyer and seller.
C) with an outstanding agreement for recurring shipments.
D) when the relationship is between countries whose currencies are considered strong.
Answer: D
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
7) From a financial management perspective, all of the following are primary risks associated
with an international trade transaction EXCEPT:
A) currency risk.
B) default risk.
C) noncompletion risk.
D) interest rate risk.
Answer: D
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
8) The risk of default on the part of the importer—risk of noncompletion—is present as soon as:
A) a price quote is given.
B) goods are received.
C) the export contract is signed.
D) the financing period begins.
Answer: D
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Conceptual
AACSB: Application of knowledge
9) Today, international trade is dominated by transactions between unaffiliated parties (known or
unknown).
Answer: FALSE
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
10) Because most international transactions are between affiliated parties, international
transaction contracts are less complex, but the management of the total value of the MNE is
more complex.
Answer: TRUE
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
11) An advantage of trading with an affiliated party for an MNE, compared to an unaffiliated
party, could be reduced contracting costs and less to even no need to protect against nonpayment.
Answer: TRUE
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
12) The fundamental dilemma of foreign trade is being unwilling to trust a stranger in a foreign
land.
Answer: TRUE
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
13) If a foreign exchange transaction calls for payment in the importer's currency, the exporter
has the foreign exchange risk.
Answer: TRUE
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
14) If a foreign exchange transaction calls for payment in the exporter's currency, the importer
has the foreign exchange risk.
Answer: TRUE
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
15) In the case of international trade, the risk of nonpayment is essentially eliminated with the
use of a letter of credit issued through a trustworthy bank.
Answer: TRUE
Diff: 1
L.O.: 16.1 The Trade Relationship
Skill: Recognition
AACSB: Application of knowledge
16) Why might different documentation be used for an export to a nonaffiliated foreign buyer
who is a new customer, as compared with an export to a nonaffiliated foreign buyer to whom the
exporter has been selling for many years?
Answer: A new nonaffiliated buyer presents a credit risk for the exporter, because the exporter
may be unable to assess the creditworthiness of that importer due to geographic distance,
language, culture, or lack of a record of payments to other suppliers. A letter of credit,
accompanied by other documents, allows the exporter to rely on the credit standing of a bank,
which is presumed to be of greater creditworthiness than just an unknown manufacturing firm.
After successful trade goes on for some time the importer becomes a known entity, in which case
the exporter will have more faith in the importer's willingness and ability to pay. Because the
letter of credit and other documents have both a financial cost and a cost for the time and energy
involved in handling the documents, direct billing for exports is easier, faster, and lowers the
final end-cost to the ultimate customer.
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Conceptual
AACSB: Application of knowledge
17) For what reason might an exporter use standard international trade documentation (letter of
credit, draft, order bill of lading) on an intrafirm export to its parent or sister subsidiary?
Answer: An export to a parent or sister subsidiary has no credit risk because both exporter and
importer are part of the same corporate unit. Non-payment to an exporter in this situation is just a
matter of keeping the firm's cash in another corporate account. In fact, very late payment for an
export to an affiliated importer might be desirable, because the firm wants to keep cash in one
location and not in another. Nevertheless, an export to an affiliated buyer might pass through the
standard documentation as a way to obtain financing that is easy to obtain, is possibly cheaper
than alternative sources of short-term financing, or provides some protection against political or
country-based interruption to payment for the transaction.
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Conceptual
AACSB: Application of knowledge
18) What is the major difference between "currency risk" and "risk of noncompletion"? How are
these risks handled in a typical international trade transaction?
Answer: Currency risk is the risk that the currency designated for payment of the import
changes in value relative to the other currency. A U.S. firm exporting to France wants dollars,
while the French importer wants to pay euros. If the sale contract specifies payment in dollars,
the French importer has a currency risk—more euros than expected might be needed when
payment is due. If the sales contract specifies payment in euros, the U.S. exporter has a currency
risk—fewer dollars than expected might be received when the euros are exchanged for dollars.
Risk of noncompletion is the risk that one of the parties fails to fulfill its obligations. The
importer may refuse to pay for the goods, or the exporter may fail to ship the goods. Events not
under the control of the parties to the trade, such as major storms, disease epidemics, terrorist
acts, or war, may make completion of the trade impossible. The several documents involved in
international trade are intended to reduce financial loss from noncompletion.
Diff: 2
L.O.: 16.1 The Trade Relationship
Skill: Conceptual
AACSB: Application of knowledge
16.2 Key Documents
1) Which of the following is NOT true regarding a letter of credit?
A) The importer and exporter agree on a transaction.
B) The importer applies to its local bank for the issuance of a letter of credit.
C) The exporter applies to its local bank for the issuance of a letter of credit.
D) The importer's bank cuts a sales contract based on its assessment of the creditworthiness of
the importer.
Answer: C
Diff: 2
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
2) A/An ________ letter of credit is intended to serve as a means of arranging payment, but not
as a guarantee of payment.
A) irrevocable
B) revocable
C) confirmed
D) unconfirmed
Answer: B
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
3) A/An ________ letter of credit is an obligation only of the issuing bank whereas other banks
honor a/an ________ letter of credit.
A) irrevocable; unconfirmed
B) revocable; confirmed
C) confirmed; irrevocable
D) unconfirmed; confirmed
Answer: D
Diff: 2
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
4) A letter of credit that is confirmed in the ________ country has the additional advantage of
eliminating the problem of ________.
A) exporter's; portfolio risk
B) importer's; blocked foreign exchange
C) exporter's; blocked foreign exchange
D) none of the above
Answer: C
Diff: 2
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
5) The draft is the instrument normally used in international commerce to:
A) transfer product.
B) prove ownership.
C) transfer title.
D) initiate the sale.
Answer: C
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
6) The ________ is the instrument normally used to actually effect payment in international
commerce.
A) banker's acceptance
B) bill of exchange
C) bill of lading
D) letter of credit
Answer: B
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
7) The person or company initiating the draft or bill of exchange is known as the:
A) maker.
B) drawer.
C) originator.
D) any of the above
Answer: D
Diff: 2
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
8) The person or company to whom the draft or bill of exchange is addressed is the:
A) drawee.
B) drawer.
C) maker.
D) originator.
Answer: A
Diff: 2
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
9) Drafts that have been accepted by banks become:
A) clean drafts.
B) nonmarketable.
C) banker's acceptances.
D) none of the above
Answer: C
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
10) Which of the following purposes is NOT served by the bill of lading?
A) It acts as a receipt.
B) It acts as a contract.
C) It acts as a document of title.
D) It acts as all of the above.
Answer: D
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
11) The ________ is issued to the exporter by a common carrier transporting the merchandise.
A) bill of lading
B) draft
C) banker's acceptance
D) line of credit
Answer: A
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
12) A straight bill of lading is most likely to be used under which of the following
circumstances?
A) when the merchandise has not been paid for in advance
B) when the transaction is being financed by a bank
C) when the shipment is to an affiliate
D) none of the above
Answer: C
Diff: 2
L.O.: 16.2 Key Documents
Skill: Conceptual
AACSB: Application of knowledge
13) To become a negotiable instrument, a draft must conform to the following requirements
EXCEPT:
A) it must be in writing and signed by the maker or drawer.
B) it must be payable to order or to bearer.
C) it must be written in English.
D) it must be payable on demand or at a fixed or determinable future date.
Answer: C
Diff: 2
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
14) In a typical international trade transaction, the order of activity would be which of the
following?
A) The foreign buyer places an order; The domestic manufacturer ships to the buyer; The
manufacturer's bank presents a draft and documents to the buyer's bank for acceptance; The
buyer's bank submits payment to the manufacturer's bank.
B) The domestic manufacturer ships to the buyer; The buyer's bank submits payment to the
manufacturer's bank; The foreign buyer places an order; The domestic manufacturer ships to the
buyer; The manufacturer's bank presents a draft and documents to the buyer's bank for
acceptance.
C) The foreign buyer places an order; The manufacturer's bank presents a draft and documents to
the buyer's bank for acceptance; The domestic manufacturer ships to the buyer; The buyer's bank
submits payment to the manufacturer's bank.
D) The domestic manufacturer ships to the buyer; The manufacturer's bank presents a draft and
documents to the buyer's bank for acceptance; The foreign buyer places an order; The buyer's
bank submits payment to the manufacturer's bank.
Answer: A
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
15) A letter of credit is an agreement by the bank to pay against documents rather than the actual
merchandise.
Answer: TRUE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
16) The primary advantage of a letter of credit is that it reduces risk.
Answer: TRUE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Conceptual
AACSB: Application of knowledge
17) The major advantage of a letter of credit to the exporter is that the exporter does not receive
any funds until the documents have arrived at a local port or airfield.
Answer: FALSE
Diff: 2
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
18) To constitute a true letter of credit transaction, the issuing bank must receive a fee or other
valid business consideration for issuing the L/C.
Answer: TRUE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
19) To constitute a true letter of credit transaction, the bank's L/C must contain a specified
expiration date or a definite maturity.
Answer: TRUE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
20) To constitute a true letter of credit transaction, the bank's commitment must be open-ended
and cannot have a stated maximum amount of money.
Answer: FALSE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
21) A revocable L/C is intended to serve as a means of arranging payment but not as a guarantee
of payment.
Answer: TRUE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
22) A sight draft is payable on presentation to the drawee; a time draft allows a delay in
payment.
Answer: FALSE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
23) A draft is sometimes called a revocable letter of credit.
Answer: FALSE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
24) A time draft is payable on presentation to the drawee; the drawee must pay at once or
dishonor the draft. A sight draft, allows a delay in payment.
Answer: FALSE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Conceptual
AACSB: Application of knowledge
25) The bill of lading is issued to the exporter by a common carrier transporting the merchandise.
It serves three purposes: a receipt, a contract, and a document of title.
Answer: TRUE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
26) Because of the risks involved in international trade, most transactions follow conventional
methods and rarely require flexibility or creativity on the part of management.
Answer: FALSE
Diff: 1
L.O.: 16.2 Key Documents
Skill: Recognition
AACSB: Application of knowledge
27) Explain what a letter of credit (L/C) is, who the principle parties are, what the principle
advantage is, and how the L/C facilitates international trade.
Answer: A letter of credit (L/C) is a bank's conditional promise to pay issued by a bank at the
request of an importer. The primary advantage of an L/C is the reduction in risk. This reduction
in risk makes it easier for the exporter to sell goods to the importer because it no longer need rely
on the ability of the importing firm to pay for the goods, but rather it can rely on the bank.
There are three primary parties involved with a letter of credit. Party number one is the exporter,
who makes a sale to the importer in exchange for the bank's L/C. Party number two is the
importer who receives the goods and promises to pay the bank. And third, the bank that contracts
with the importer and agrees to pay the exporter upon presentation of documents as specified in
the L/C.
The advantage to an exporter is the increased likelihood of receiving payment because funds are
due from a known international commercial bank as opposed to a relatively unknown importer.
Furthermore, an exporter with a good reputation for delivery may be able to sell the L/C at a
discount in the secondary market prior to shipping and speed up cash flow.
The importer benefits because it doesn't need to pay for goods purchased until they actually
reach port. The bank benefits from the fees they charge.
Diff: 3
L.O.: 16.2 Key Documents
Skill: Conceptual
AACSB: Application of knowledge
16.3 Government Programs to Help Finance Exports
1) The Export-Import Bank is an independent agency of the U.S. government established in 1934
to:
A) ship money abroad.
B) import agricultural products during the recession.
C) facilitate and stimulate foreign trade of the United States.
D) none of the above
Answer: C
Diff: 2
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
2) In the United States, the Foreign Credit Insurance Corporation:
A) is a subsidiary of the Export-Import Bank.
B) provides letters of credit for U.S. importers.
C) provides letters of credit for U.S. exporters.
D) provides policies that protect U.S. exporters against default by foreign importers.
Answer: D
Diff: 2
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
3) The Eximbank does all of the following EXCEPT:
A) guarantees lease transactions.
B) supplies counseling for exporters in finding financing for U.S. goods.
C) finances the cost involved in the preparation of feasibility studies for non-U.S. clients
D) provides letters of credit for U.S. exporters.
Answer: D
Diff: 2
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
4) The Foreign Credit Insurance Association is a branch of the U.S. federal government.
Answer: FALSE
Diff: 1
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
5) The Export-Import Bank (also called Eximbank) is an independent agency of the U.S.
government, established in 1934 to stimulate and facilitate the foreign trade of the United States.
Answer: TRUE
Diff: 1
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
6) Essentially, the Eximbank lends dollars to borrowers inside the United States for the purchase
of U.S. goods and services.
Answer: FALSE
Diff: 1
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
7) In the United States, domestic taxpayers bear the cost of export credit insurance and export
financing provided by institutions like the FCIA and Eximbank to foreign buyers in order to
create employment and maintain a technological edge.
Answer: TRUE
Diff: 1
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
8) Export credit insurance provides assurance to the exporter or the exporter's bank that, should
the foreign customer default on payment, the insurance company will pay for a major portion of
the loss.
Answer: TRUE
Diff: 1
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
9) One way a nation can improve its exports is by shortening the period for which credit
transactions can be insured.
Answer: FALSE
Diff: 1
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
10) The European Union recommends maximum credit terms for many items including, for
example, heavy capital goods (five years), light capital goods (three years), and consumer
durable goods (one year).
Answer: FALSE
Diff: 1
L.O.: 16.3 Government Programs to Help Finance Exports
Skill: Recognition
AACSB: Application of knowledge
16.4 Trade Financing Alternatives
Instruction 16.1:
Use the information to answer the following question(s).
Cypress Systems Inc., of Florida, agrees to sell specialized hydroponic growing equipment to
Landcaster's of Australia. Because the two companies have never done business with each other,
Cypress requires a banker's acceptance as payment for the $1,000,000 order. The banker's
acceptance carries a 1.4% commission per annum and payment is to be received in 6 months. If
Cypress Inc. chooses to discount or sell the banker's acceptance to its bank, the discount rate is
1.00% per annum.
1) Refer to Instruction 16.1. What is the size of the discount (not including the commission fee)
Cypress must take for receiving the proceeds of the sale today rather than waiting for six
months?
A) $7,000
B) $5,000
C) $12,000
D) $14.000
Answer: B
Diff: 3
L.O.: 16.4 Trade Financing Alternatives
Skill: Analytical
AACSB: Analytical thinking
2) Refer to Instruction 16.1. What is the size of the commission Cypress will pay the bank for the
banker's acceptance?
A) $7,000
B) $5,000
C) $12,000
D) $14,000
Answer: A
Diff: 3
L.O.: 16.4 Trade Financing Alternatives
Skill: Analytical
AACSB: Analytical thinking
3) Refer to Instruction 16.1. What is the total Cypress can expect to receive if the firm takes
payment today?
A) $993,000
B) $995,000
C) $988,000
D) $996,000
Answer: C
Diff: 3
L.O.: 16.4 Trade Financing Alternatives
Skill: Analytical
AACSB: Analytical thinking
4) Refer to Instruction 16.1. ________ is an unsecured promissory note.
A) A banker's acceptance
B) An overdraft
C) A securitized loan
D) Commercial paper
Answer: D
Diff: 3
L.O.: 16.4 Trade Financing Alternatives
Skill: Recognition
AACSB: Application of knowledge
5) Rogue Spices Inc. has a Canadian receivables contract for $200,000 due in 270 days. The firm
has been approached by a factoring firm that offers to purchase the receivables at a 12% per
annum discount plus a 1% charge for a nonrecourse clause. What is the annualized percentage
all-in-cost of this factoring alternative?
A) 14.82%
B) 13.00%
C) 12.00%
D) 9.09%
Answer: A
Diff: 3
L.O.: 16.4 Trade Financing Alternatives
Skill: Analytical
AACSB: Analytical thinking
6) Export receivables are normally sold at a discount. The size of the discount depends on the
following factors EXCEPT:
A) overdraft fees.
B) collection risk.
C) cost of credit insurance.
D) size of financing and services fees.
Answer: A
Diff: 3
L.O.: 16.4 Trade Financing Alternatives
Skill: Analytical
AACSB: Application of knowledge
7) Banker's acceptances are used to finance only international trade receivables but not domestic
trade receivables.
Answer: FALSE
Diff: 1
L.O.: 16.4 Trade Financing Alternatives
Skill: Recognition
AACSB: Application of knowledge
8) The first owner of the bankers' acceptance created from an international trade transaction will
be the importer, who receives the endorsed draft back after the bank has stamped it "accepted."
Answer: FALSE
Diff: 2
L.O.: 16.4 Trade Financing Alternatives
Skill: Recognition
AACSB: Application of knowledge
9) An overdraft agreement allows a firm to overdraw its bank account up to the limit of its credit
line.
Answer: TRUE
Diff: 2
L.O.: 16.4 Trade Financing Alternatives
Skill: Recognition
AACSB: Application of knowledge
10) Issuing commercial papers to finance accounts receivable or short-term financing needs lies
at the low end of the pecking order of trade financing alternatives.
Answer: FALSE
Diff: 2
L.O.: 16.4 Trade Financing Alternatives
Skill: Recognition
AACSB: Application of knowledge
11) Recourse means that the factor assumes the credit, political, and foreign exchange risk for
the receivables it purchases.
Answer: FALSE
Diff: 2
L.O.: 16.4 Trade Financing Alternatives
Skill: Recognition
AACSB: Application of knowledge
12) The firm selling the recourse receivables avoids the cost of determining the creditworthiness
of its customers.
Answer: FALSE
Diff: 2
L.O.: 16.4 Trade Financing Alternatives
Skill: Recognition
AACSB: Application of knowledge
13) What is a banker's acceptance? How are they initiated? Why are they desirable for the
exporter?
Answer: A draft, or bill of exchange, is a written order from the exporter telling the importer
when and how much to pay. When properly contracted, a draft can become a negotiable
instrument and trade in the secondary market. If the draft provides a specific payment date and is
presented to the importer's bank, it becomes a banker's acceptance (BA) and the bank makes an
unconditional promise to make payment upon maturity. A BA may sell in the secondary market
like any other marketable security and the holder need not wait until maturity to liquidate. Thus,
BAs facilitate trade by reducing risk and potentially speeding cash flows to the exporter.
Diff: 3
L.O.: 16.4 Trade Financing Alternatives
Skill: Conceptual
AACSB: Application of knowledge
16.5 Forfaiting: Medium- and Long-Term Financing
1) ________ is a specialized technique to eliminate the risk of nonpayment by importers in
instances where the importing firm and/or its government is perceived by the exporter to be too
risky for open account credit.
A) Forfeiting
B) Marketable Bank Shares
C) Forfaiting
D) Banker's Acceptances
Answer: C
Diff: 1
L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT true about forfaiting?
A) The exporter is responsible for the quality of delivered goods.
B) Exporter receives an unconditional cash payment at the time of the transaction.
C) The exporter sells bank-guaranteed promissory notes at its face value.
D) The political and commercial risk is carried by the guaranteeing bank.
Answer: C
Diff: 2
L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition
AACSB: Application of knowledge
3) A typical forfaiting transaction involves the following parties EXCEPT:
A) importer.
B) exporter.
C) carrier.
D) importer's Bank.
Answer: C
Diff: 1
L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition
AACSB: Application of knowledge
4) The following parties are usually guarantors in forfaiting EXCEPT:
A) commercial banks.
B) government ministries of finance.
C) large commercial enterprises.
D) government banks.
Answer: C
Diff: 1
L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition
AACSB: Application of knowledge
5) In effect, the forfaiter functions both as a money market firm and a specialist in packaging
financial deals involving country risk.
Answer: TRUE
Diff: 1
L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition
AACSB: Application of knowledge
6) Success of the forfaiting technique springs from the belief that the aval can be depended on.
Answer: TRUE
Diff: 1
L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition
AACSB: Application of knowledge
7) The liability of the aval is an "on balance sheet" obligation for the endorsing bank.
Answer: FALSE
Diff: 1
L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 17 Foreign Direct Investment and Political Risk
17.1 The Foreign Direct Investment Decision
1) Based on observations of firms that have successfully invested abroad, we can conclude that
one of the competitive advantages enjoyed by MNEs is:
A) managerial expertise.
B) financial strength.
C) competitiveness of their home markets.
D) All of the above are competitive advantages.
Answer: D
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
2) Based on observations of firms that have successfully invested abroad, we can conclude
companies are more competitive when:
A) facing sophisticated and demanding customers in the home market.
B) surrounded by a critical mass of related industries and suppliers.
C) located in countries that are naturally endowed with the appropriate factors of production.
D) All of the above are true.
Answer: D
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
3) The OLI paradigm is an attempt to create a framework to explain why MNEs choose
________ rather than some other form of international venture.
A) licensing
B) joint ventures
C) foreign direct investment
D) strategic alliances
Answer: C
Diff: 1
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
4) The O in OLI refers to an advantage in a firm's home market that is:
A) operator independent.
B) owner-specific.
C) open-market.
D) official designation.
Answer: B
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
5) The owner-specific advantages of OLI must be:
A) firm-specific.
B) not easily copied.
C) transferable to foreign subsidiaries.
D) all of the above
Answer: D
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
6) A/An ________ would be an example of an owner-specific advantage for an MNE.
A) patent
B) economy of scale
C) economy of scope
D) all of the above
Answer: A
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Conceptual
AACSB: Application of knowledge
7) The L in OLI refers to an advantage in a firm's home market that is a:
A) liability in the domestic market.
B) location-specific advantage.
C) longevity in a particular market.
D) none of the above
Answer: B
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
8) A/An ________ would be an example of a location-specific advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information
Answer: C
Diff: 1
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Conceptual
AACSB: Application of knowledge
9) The I in OLI refers to an advantage in a firm's home market that is an:
A) internalization.
B) industry-specific advantage.
C) international abnormality.
D) none of the above
Answer: A
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
10) A/An ________ would be an example of an internalization advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information
Answer: D
Diff: 1
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Conceptual
AACSB: Application of knowledge
11) In deciding whether to invest abroad, management must first determine whether the firm has
a sustainable competitive advantage that enables it to compete effectively in the home market.
The competitive advantage must be:
A) firm specific.
B) not easily copied.
C) in a transferable form.
D) all of the above
Answer: D
Diff: 1
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Conceptual
AACSB: Application of knowledge
12) Which of the following is NOT a market imperfection or genuine comparative advantage that
attracts FDI to particular locations?
A) low cost and productive labor force
B) unique sources of raw materials
C) defensive investments
D) an expansive monetary policy
Answer: D
Diff: 1
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Conceptual
AACSB: Application of knowledge
13) A strongly competitive home market tends to dull the competitive advantage relative to firms
located in less competitive home markets.
Answer: FALSE
Diff: 3
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
14) Reactive financial strategies can be formulated in advance by the MNE's financial managers.
Answer: FALSE
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
15) Proactive financial strategies depend on discovering market imperfections.
Answer: FALSE
Diff: 2
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Recognition
AACSB: Application of knowledge
16) List and explain three strategic motives why firms could become multinationals and give an
example of each.
Answer: The strategic motives for firms to become multinationals could be: market seekers, raw
materials seekers, production efficiency seekers, knowledge seekers, and political safety seekers.
Market seekers are looking for more consumers for their products such as automobiles, or steel.
Knowledge seekers may be looking for an educated workforce similar to the way firms seeking
R and D set up shop in university towns. Raw materials seekers may be after commodities such
as oil or copper. Production efficiencies may occur in countries like Mexico that have capable
workers and lower wages. Political safety seekers are looking for countries that will not
expropriate their assets, so they may stay away from countries that in the post have engaged in
such activities.
Diff: 3
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Conceptual
AACSB: Application of knowledge
17) What does the OLI Paradigm propose to explain? Define each component and provide an
example of each.
Answer: The OLI Paradigm is an attempt to develop an overall framework to explain why
MNEs choose FDI to serve foreign markets rather than alternatives such as licensing or
exporting. The letters of the paradigm are O for owner-specific advantages, L for location-
specific advantages, and I for internalization.
Owner-specific advantages require that the firm have a comparative advantage in its home
market that it feels it can exploit internationally. To be most effective, the advantages should be
difficult to copy. Location specific advantages may be due to market imperfections or genuine
comparative advantages such as a source of a particularly high quality natural resource. With
internalization the firm has in its possession some proprietary information or product such as
software or personnel that may provide an advantage in the international marketplace.
Diff: 3
L.O.: 17.1 The Foreign Direct Investment Decision
Skill: Conceptual
AACSB: Application of knowledge
17.2 Structural Choices for Foreign Market Entry
1) Which of the following is NOT true regarding behavioral observations of firms making a
decision to invest internationally?
A) MNEs initially invest in countries with a similar "national psychic."
B) Firms eventually take greater risks in terms of the national psychic of countries in which they
invest.
C) Initial investments tend to be much larger than subsequent ones.
D) All of the above have been observed.
Answer: C
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT an advantage to exporting goods to reach international
markets rather than entering into some form of FDI?
A) fewer political risks
B) greater agency costs
C) lower front-end investment
D) All of the above are advantages.
Answer: B
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
3) Which of the following is an advantage to exporting goods to reach international markets
rather than entering into some form of FDI?
A) fewer agency costs
B) fewer direct advantages from research and development
C) a greater risk of losing markets to copycat goods producers
D) an inability to exploit R&D as effectively as if also invested abroad
Answer: A
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
4) Which of the following is NOT a form of FDI?
A) wholly-owned affiliate
B) joint venture
C) exporting
D) greenfield investment
Answer: C
Diff: 1
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
5) With licensing the ________ is likely to be lower than with FDI because of lower profits;
however, the ________ is likely to be higher due to a greater return per dollar invested.
A) IRR; NPV
B) NPV; IRR
C) cost of capital; NPV
D) IRR; cost of capital
Answer: B
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
6) Which of the following is NOT a potential disadvantage of licensing relative to FDI?
A) possible loss of quality control
B) establishment of a potential competitor in third-country markets
C) possible improvement of the technology by the local licensee, which then enters the original
firm's home market
D) All of the above are potential disadvantages to licensing.
Answer: D
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
7) A ________ is a shared ownership in a foreign business.
A) licensing agreement
B) greenfield investment
C) joint venture
D) wholly-owned affiliate
Answer: C
Diff: 1
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
8) Which of the following is NOT an advantage to a joint venture?
A) Possible loss of opportunity to enter the foreign market with FDI later.
B) The local partner understands the customs and mores of the foreign market.
C) The local partner can provide competent management at many levels.
D) May be a realistic alternative when 100% foreign ownership is not allowed.
Answer: A
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
9) Greenfield investments are typically ________ and ________ than cross-border acquisition.
A) slower; more uncertain
B) faster; of greater certainty
C) slower; of greater certainty
D) faster; more uncertain
Answer: A
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
10) All of the following may be justification for a strategic alliance EXCEPT:
A) takeover defense.
B) a joint venture to pool resources for research and development.
C) joint marketing and serving agreements.
D) All of the above are legitimate reasons for strategic alliances.
Answer: D
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
11) In practice, when expanding into other countries, firms have been observed to follow a
sequential search pattern as described in the behavioral theory of the firm.
Answer: TRUE
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
12) As a general rule, the decision about where to invest abroad for the first time is the same as
the decision about where to reinvest abroad.
Answer: FALSE
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
13) Economists have observed that firms tend to invest first in countries that are too far distant in
psychic distance (similar cultural, legal, and institutional environment).
Answer: FALSE
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
14) Transnationals are firms that have operations in more than one country and conduct their
business through branches, foreign subsidiaries, or joint ventures with host country firms.
Answer: FALSE
Diff: 2
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
15) Licensing is a popular form of foreign investment because it does not need a sizable
commitment of funds, and political risk is often minimized.
Answer: TRUE
Diff: 1
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
16) MNEs typically used licensing with independent firms rather than with their own foreign
subsidiaries.
Answer: FALSE
Diff: 1
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
17) Joint ventures are a more common FDI than wholly owned subsidiaries.
Answer: FALSE
Diff: 1
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Recognition
AACSB: Application of knowledge
18) Local partners in a foreign country and in a joint venture with an MNE are likely to make
decisions that maximize the value of the subsidiary. Such actions probably will not maximize the
value of the entire firm.
Answer: TRUE
Diff: 1
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
19) The decision about where to invest abroad is influenced by behavioral factors. Explain the
behavioral approach to FDI.
Answer: The behavioral approach to analyzing the FDI decision is typified by the so-called
Swedish School of economists. The Swedish School has rather successfully explained not just
the initial decision to invest abroad, but also later decisions to reinvest elsewhere, and to change
the structure of a firm's international involvement over time. Based on the internationalization
process of a sample of Swedish MNEs, the economists observed that these firms tended to invest
first in countries that were not too far distant in psychic terms. Close psychic distance defined
countries with a cultural, legal, and institutional environment similar to Sweden's, such as
Norway, Denmark, Finland, Germany, and the United Kingdom. The initial investments were
modest in size, to minimize the risk of an uncertain foreign environment. As the Swedish firms
learned from their initial investments, they became willing to take greater risks with respect to
both the psychic distance of the countries, and the size of the investments.
Diff: 3
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
20) What are the advantages and disadvantages of serving a foreign market through a greenfield
foreign direct investment compared to an acquisition of a local firm in the target market?
Answer: A greenfield investment is defined as establishing a production or service facility
starting from the ground up, i.e., from a green field. Compared to greenfield investment, a cross-
border acquisition has a number of significant advantages. First and foremost, it is quicker.
Greenfield investment frequently requires extended periods of physical construction and
organizational development. By acquiring an existing firm, the MNE can shorten the time
required to gain a presence and facilitate competitive entry into the market. Second, acquisition
may be a cost-effective way of gaining competitive advantages such as technology, brand names
valued in the target market, and logistical and distribution advantages, while simultaneously
eliminating a local competitor. Third, international economic, political, and foreign exchange
conditions may result in market imperfections, allowing target firms to be undervalued. Many
enterprises throughout Asia have been the target of acquisition as a result of the Asian economic
crisis's impact on their financial health. Many enterprises were in dire need of capital injections
for competitive survival.
Cross-border acquisitions are not, however, without their pitfalls. As with all acquisitions—
domestic or international—there are the frequent problems of paying too high a price, or
suffering a method of financing that is too costly. Meshing different corporate cultures can be
traumatic. Managing the post-acquisition process is frequently characterized by downsizing to
gain economies of scale and scope in overhead functions. This results in nonproductive impacts
on the firm as individuals attempt to save their own jobs. Internationally, additional difficulties
arise from host governments intervening in pricing, financing, employment guarantees, market
segmentation, and general nationalism and favoritism. In fact, the ability to complete
international acquisitions successfully may itself be a test of the MNE's competence in the
twenty-first century.
Diff: 3
L.O.: 17.2 Structural Choices for Foreign Market Entry
Skill: Conceptual
AACSB: Application of knowledge
17.3 Political Risk: Definition and Classification
1) ________ risks are those that affect the MNE at the local or project level, but originate at the
country level.
A) Country-specific
B) Firm-specific
C) Global-specific
D) none of the above
Answer: A
Diff: 2
L.O.: 17.3 Political Risk: Definition and Classification
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT an example of a country-specific risk?
A) transfer risk
B) war and ethnic strife
C) cultural and religious heritage
D) All of the above are examples of country-specific risk.
Answer: D
Diff: 2
L.O.: 17.3 Political Risk: Definition and Classification
Skill: Recognition
AACSB: Application of knowledge
3) ________ is NOT one of the three main country-specific risks as outlined by your authors.
A) Transfer risk
B) Cultural differences
C) Thin equity base
D) Protectionism
Answer: C
Diff: 2
L.O.: 17.3 Political Risk: Definition and Classification
Skill: Recognition
AACSB: Application of knowledge
4) A number of institutional services provide updated country risk ratings on a regular basis. This
is an example of micro-risk information for MNEs using this data.
Answer: FALSE
Diff: 2
L.O.: 17.3 Political Risk: Definition and Classification
Skill: Recognition
AACSB: Application of knowledge
17.4 Financial Impacts of Political Risk
1) According to your authors, MNEs can anticipate government regulations that are
discriminatory or wealth depriving from a/an ________ or ________ level view.
A) foreign; domestic
B) micro; macro
C) internal; external
D) local; global
Answer: B
Diff: 2
L.O.: 17.4 Financial Impacts of Political Risk
Skill: Conceptual
AACSB: Application of knowledge
2) Of the following, which would NOT be considered an issue for an investment agreement prior
to investing in a foreign country?
A) the basis for setting transfer prices
B) the right to export to third-country markets
C) provision for arbitration of disputes
D) All of the above could be negotiated prior to investing.
Answer: D
Diff: 2
L.O.: 17.4 Financial Impacts of Political Risk
Skill: Conceptual
AACSB: Application of knowledge
3) ________ is the risk that the host government will take specific steps that prevent the foreign
affiliate from exercising control over the firm's assets.
A) Inconvertibility
B) Expropriation
C) Business income risk
D) none of the above
Answer: B
Diff: 1
L.O.: 17.4 Financial Impacts of Political Risk
Skill: Recognition
AACSB: Application of knowledge
17.5 Political Risk Mitigation
1) Blocked funds are cash flows that:
A) come in regular intervals in standardized amounts or blocks.
B) have been restricted in transfer out of a local country.
C) come from a certain sector or region of the world.
D) none of the above
Answer: B
Diff: 2
L.O.: 17.5 Political Risk Mitigation
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT one of the stages at which MNEs can react to the potential for
blocked funds?
A) prior to investing
B) during operations
C) reinvesting in the local country when funds cannot be moved
D) All of the above are stages at which MNEs can react.
Answer: D
Diff: 2
L.O.: 17.5 Political Risk Mitigation
Skill: Recognition
AACSB: Application of knowledge
3) A ________ loan, also known as ________ is a parent-to-affiliate loan channeled through a
financial intermediary such as a large commercial bank.
A) fronting; link financing
B) parallel; a back-to-back loan
C) fronting; a back-to-back loan
D) link financing; parallel loan
Answer: A
Diff: 2
L.O.: 17.5 Political Risk Mitigation
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT a typical characteristic of a fronting loan made to an
international subsidiary?
A) The parent makes a deposit equal to the size of the desired loan into a large commercial bank.
B) The bank lends to the subsidiary firm an amount equal to the parent deposit at a slightly
higher interest rate.
C) The lending bank is located in the subsidiary's country.
D) All of the above are typical characteristics of a fronting loan.
Answer: C
Diff: 2
L.O.: 17.5 Political Risk Mitigation
Skill: Recognition
AACSB: Application of knowledge
5) Which of the following could be considered an example of forced reinvestment if the
blockage of funds was expected to be temporary?
A) vertical reinvestment by an automobile manufacturer to buy parts suppliers and showrooms
B) a lumber cutting company subsequently builds a paper mill with blocked funds
C) purchase of local money market instruments and short-term loans
D) all of the above
Answer: C
Diff: 2
L.O.: 17.5 Political Risk Mitigation
Skill: Conceptual
AACSB: Application of knowledge
6) OPIC stands for:
A) Organization for the Prevention of Insufficient Capitalization.
B) Organization of Petroleum Importing Countries.
C) Overseas Private Investment Corporation.
D) Overseas Public Insurance Commission.
Answer: C
Diff: 2
L.O.: 17.5 Political Risk Mitigation
Skill: Recognition
AACSB: Application of knowledge
7) ________ is a type of political risk that OPIC does NOT cover.
A) Inconvertibility
B) Expropriation
C) War
D) OPIC covers all of the above.
Answer: D
Diff: 2
L.O.: 17.5 Political Risk Mitigation
Skill: Recognition
AACSB: Application of knowledge
8) A country can react to the potential for blocked funds prior to making an investment, during
operations, or by investing in the local country in assets than maintain their value.
Answer: TRUE
Diff: 1
L.O.: 17.5 Political Risk Mitigation
Skill: Conceptual
AACSB: Application of knowledge
9) Banks are very hesitant to engage in fronting loans because of the low probability of
repayment and thus their risk exposure up to a 100% loss.
Answer: FALSE
Diff: 1
L.O.: 17.5 Political Risk Mitigation
Skill: Conceptual
AACSB: Application of knowledge
10) What are blocked funds? List and explain two of the three methods the authors list in this
chapter for dealing with blocked funds.
Answer: Blocked funds are those that have been restricted from foreign exchange in some
fashion by the government of the host country. If this is a potential problems firms take a number
of steps to reduce or minimize the impact of such a governmental action. In this chapter the
authors identify three techniques for dealing with the problem of blocked funds. First, using
fronting loans. Here the firm deposits money into a large financial institution, typically in a
neutral third country, and then has the bank loan the same amount to the foreign subsidiary.
There are several reasons why governments are more likely to allow repayments of such loans as
opposed to repayment to the parent.
Second, the local firm may create new exports thus increasing the flow of currency into the
country and achieving the goals of the government. Third, the authors also mention a special
dispensation whereby firms in highly desirable and specialized industries such as
telecommunications or pharmaceuticals are contractually guaranteed repatriation of funds at a
greater rate than normal.
Diff: 3
L.O.: 17.5 Political Risk Mitigation
Skill: Conceptual
AACSB: Application of knowledge
11) An investment agreement spells out specific rights and responsibilities of both the foreign
firm and the host government. What are the main financial policies that should be included in an
investment agreement?
Answer: An investment agreement spells out specific rights and responsibilities of both the
foreign firm and the host government. The presence of MNEs is as often sought by development-
seeking host governments as a particular foreign location is sought by an MNE. All parties have
alternatives, and so bargaining is appropriate. An investment agreement should spell out policies
on financial and managerial issues, including the following:
- The basis on which fund flows, such as dividends, management fees, royalties, patent fees, and
loan repayments, may be remitted.
- The basis for setting transfer prices.
- The right to export to third-country markets.
- Obligations to build, or fund, social and economic overhead projects, such as schools, hospitals,
and retirement systems.
- Methods of taxation, including the rate, the type of taxation, and means by which the rate base
is determined.
- Access to host-country capital markets, particularly for long-term borrowing.
- Permission for 100% foreign ownership versus required local ownership (joint venture)
participation.
- Price controls, if any, applicable to sales in the host-country markets.
- Requirements for local sourcing versus import of raw materials and components.
- Permission to use expatriate managerial and technical personnel, and to bring them and their
personal possessions into the country free of exorbitant charges or import duties.
- Provision for arbitration of disputes.
- Provisions for planned divestment, should such be required, indicating how the going concern
will be valued and to whom it will be sold.
Diff: 3
L.O.: 17.5 Political Risk Mitigation
Skill: Conceptual
AACSB: Application of knowledge
Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)
Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions
18.1 Complexities of Budgeting for a Foreign Project
1) The traditional financial analysis applied to foreign or domestic projects, to determine the
project's value to the firm is called:
A) cost of capital analysis.
B) capital budgeting.
C) capital structure analysis.
D) agency theory.
Answer: B
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following is NOT a basic step in the capital budgeting process?
A) Identify the initial capital invested.
B) Estimate the cash flows to be derived from the project over time.
C) Identify the appropriate interest rate at which to discount future cash flows.
D) All of the above are steps in the capital budgeting process.
Answer: D
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
3) Of the following capital budgeting decision criteria, which does NOT use discounted cash
flows?
A) net present value
B) internal rate of return
C) accounting rate of return
D) All of these techniques typically use discounted cash flows.
Answer: C
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT a reason why capital budgeting for a foreign project is more
complex than for a domestic project?
A) Parent cash flows must be distinguished from project cash flows.
B) Parent firms must specifically recognize remittance of funds due to differing rules and
regulations concerning remittance of cash flows, taxes, and local norms.
C) Differing rates of inflation exist between the foreign and domestic economies.
D) All of the above add complexity to the international capital budgeting process.
Answer: D
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
5) For purposes of international capital budgeting, which of the following statements is NOT
true?
A) Managers must evaluate political risk because political events can drastically reduce the value
or availability of expected cash flows.
B) Parent cash flows must be distinguished from project cash flows. Each of these two types of
flows contributes to a different view of value.
C) An array of nonfinancial payments can generate cash flows from subsidiaries to the parent,
including payment of license fees and payments for imports from the parent.
D) All of the above are true statements.
Answer: D
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
6) Project evaluation from the ________ viewpoint serves some useful purposes and/but should
________ the ________ viewpoint.
A) local; be subordinated to; parent's
B) local; not be subordinated to; parent's
C) parent's; be subordinated to; local
D) none of the above
Answer: A
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
7) For financial reporting purposes, U.S. firms must consolidate the earnings of any subsidiary
that is over ________ owned.
A) 20%
B) 40%
C) 50%
D) 75%
Answer: C
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
8) A foreign firm that is 20% to 49% owned by a parent is called a/an:
A) subsidiary.
B) affiliate.
C) partner.
D) rival.
Answer: B
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
9) Affiliate firms are consolidated on the parent's financial statements on a ________ basis.
A) pro rated
B) 50%
C) 75%
D) 100%
Answer: A
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
10) When engaged in international capital budgeting, the analyst must identify the initial amount
of capital invested or put at risk.
Answer: TRUE
Diff: 1
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
11) In international capital budgeting, the appropriate discount rate for determining the present
value of the expected cash flows is always the firm's domestic WACC.
Answer: FALSE
Diff: 1
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Conceptual
AACSB: Application of knowledge
12) For purposes of international capital budgeting, it is NOT important to distinguish between
parent and total project cash flows.
Answer: FALSE
Diff: 1
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Conceptual
AACSB: Application of knowledge
13) For purposes of international capital budgeting, parent cash flows often depend on the form
of financing. Thus, we cannot clearly separate cash flows from financing decisions, as we can in
domestic capital budgeting.
Answer: TRUE
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
14) There are no important differences between domestic and international capital budgeting
methods.
Answer: FALSE
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
15) It is important that firms adopt a common standard for the capital budgeting process for
choosing among foreign and domestic projects.
Answer: TRUE
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
16) The only proper way to estimate the NPV of a foreign project is to discount the appropriate
cash flows first and then convert them to the domestic currency at the current spot rate.
Answer: FALSE
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Conceptual
AACSB: Application of knowledge
17) For purposes of international capital budgeting, evaluation of a project from the PARENT
viewpoint serves some useful purposes, but it should be subordinated to evaluation from the
LOCAL's viewpoint.
Answer: FALSE
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Recognition
AACSB: Application of knowledge
18) Multinational firms should invest only if they can earn a risk-adjusted return greater than
locally based competitors can earn on the same project.
Answer: TRUE
Diff: 2
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Conceptual
AACSB: Application of knowledge
19) The authors highlight a strong theoretical argument in favor of analyzing any foreign project
from the viewpoint of the parent. Provide at least three reasons why the parent's viewpoint is
superior to the local viewpoint and give an example of when the local viewpoint fails to
maximize the value of the firm.
Answer: A project might have a positive NPV from the local viewpoint, but fail to consider
relevant cash flows from the parent viewpoint. For example, a positive NPV project in one
country may result from the erosion of revenues in another. A local manager would not
necessarily be expected to be aware of such erosion. It may not be possible to remit all or part of
the local cash flows to the parent company and reinvestment opportunities in the local economy
may be inferior to what the parent could do elsewhere, thus, a less than maximum use of funds.
Political and exchange rate risk add to the uncertainty of cash flows and thus increase the
required rate of return by stockholders. Cash flows may be more difficult to estimate especially
long-term cash flows in lesser-developed countries.
Diff: 3
L.O.: 18.1 Complexities of Budgeting for a Foreign Project
Skill: Conceptual
AACSB: Application of knowledge
18.2 Illustrative Case: Cemex Enters Indonesia
1) Which of the following is NOT an example of political risk?
A) Expropriation of cash flows by a foreign government.
B) The U.S. government restricts trade with a foreign country where your firm has investments.
C) The foreign government nationalizes all foreign-owned assets.
D) All of the above are examples of political risk.
Answer: D
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
2) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of
6% in Norway and 3% per annum in the U.S., use the formula for relative purchasing power
parity to estimate the one-year spot rate of krone per dollar.
A) 7.87 krone per dollar
B) 8.10 krone per dollar
C) 8.34 krone per dollar
D) There is not enough information to answer this question.
Answer: C
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Analytical
AACSB: Analytical thinking
3) When evaluating capital budgeting projects, which of the following would NOT necessarily
be an indicator of an acceptable project?
A) an NPV > $0
B) an IRR > the project's required rate of return
C) an IRR > $0
D) All of the above are correct indicators.
Answer: C
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
4) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of
3% in Norway and 6% per annum in the U.S., use the formula for relative purchasing power
parity to estimate the one-year spot rate of krone per dollar.
A) 7.87 krone per dollar
B) 8.10 krone per dollar
C) 8.34 krone per dollar
D) There is not enough information to answer this question.
Answer: A
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Analytical
AACSB: Analytical thinking
5) When determining a firm's weighted average cost of capital (WACC), which of the following
terms is NOT necessary?
A) the firm's tax rate
B) the firm's cost of debt
C) the firm's cost of equity
D) All of the above are necessary.
Answer: D
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
6) When determining a firm's weighted average cost of capital (WACC), which of the following
terms is NOT necessary?
A) the firm's weight of equity financing
B) the risk-free rate of return
C) the firm's weight of debt financing
D) All of the above are necessary to determine a firm's WACC.
Answer: B
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
Instruction 18.1:
Use the information to answer the following question(s).
The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers, scooters
and other wheeled non-motorized recreational equipment, is considering an expansion of their
product line to Europe. The expansion would require a purchase of equipment with a price of
1,200,000 and additional installation of 300,000 (assume that the installation costs cannot be
expensed, but rather, must be depreciated over the life of the asset). Because this would be a new
product, they will not be replacing existing equipment. The new product line is expected to
increase revenues by 600,000 per year over current levels for the next 5 years, however;
expenses will also increase by 200,000 per year. (Note: Assume the after-tax operating cash
flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total
after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that
they will sell it at the end of the five years for 500,000. The firm's required rate of return is 12%
and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-
year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC
of 100,000 (to be recovered at the sale of the equipment at the end of five years). The current
spot rate is $0.95/euro, and the expected inflation rate in the U.S. is 4% per year and 3% per year
in Europe.
7) Refer to Instruction 18.1. What is the initial investment for the Velo Rapid Revolutions
project?
A) $1,500,000
B) 1,600,000
C) $1,600,000
D) 1,500,000
Answer: A
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Analytical
AACSB: Analytical thinking
8) Refer to Instruction 18.1. What are the annual after-tax cash flows for the Velo Rapid
Revolutions project?
A) 400,000
B) 240,000
C) 120,000
D) 360,000
Answer: D
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Analytical
AACSB: Analytical thinking
9) Refer to Instruction 18.1. What is the NPV of the European expansion if Velo Rapid
Revolutions first computes the NPV in euros and then converts that figure to dollars using the
current spot rate?
A) $1,520,000
B) $1,684,210
C) -$75,310
D) -$71,544
Answer: D
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Analytical
AACSB: Analytical thinking
10) Refer to Instruction 18.1. In euros, what is the NPV of the Velo Rapid Revolutions
expansion?
A) 1,524,690
B) $1,611,317
C) -75,310
D) -111,317
Answer: C
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Analytical
AACSB: Analytical thinking
11) Refer to Instruction 18.1. What is the IRR of the Velo Rapid Revolutions expansion?
A) 14.4%
B) 10.3%
C) 12.0%
D) 8.6%
Answer: B
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Analytical
AACSB: Analytical thinking
12) If a firm undertakes a project with ordinary cash flows and estimates that the firm has a
positive NPV, then the IRR will be:
A) less than the cost of capital.
B) greater than the cost of capital.
C) greater than the cost of the project.
D) cannot be determined from this information
Answer: B
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
13) When estimating a firm's cost of equity capital using the CAPM, you need to estimate:
A) the risk-free rate of return.
B) the expected return on the market portfolio.
C) the firm's beta.
D) all of the above
Answer: D
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
14) ________ is the risk that a foreign government will place restrictions such as limiting the
amount of funds that can be remitted to the parent firm, or even expropriation of cash flows
earned in that country.
A) Exchange risk
B) Foreign risk
C) Political risk
D) Unnecessary risk
Answer: C
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
15) Generally speaking, a firm wants to receive cash flows from a currency that is ________
relative to their own, and pay out in currencies that are ________ relative to their home currency.
A) appreciating; depreciating
B) depreciating; depreciating
C) appreciating; appreciating
D) depreciating; appreciating
Answer: A
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Conceptual
AACSB: Application of knowledge
16) When assessing the additional risk that can occur from investing abroad, firms may choose to
account for risk via:
A) adjusting the cash flows.
B) adjusting the discount rates.
C) adjusting both cash flows and discount rates.
D) adjusting all of the above.
Answer: D
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
17) When a multinational firm invests abroad, it is common to develop two capital budgets: one
from the project viewpoint, and one from the parent viewpoint.
Answer: TRUE
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
18) When estimating a capital budget, it is common to separate cash flows into: 1) the initial
investment, 2) incremental cash flows over the life of the project, and 3) a terminal value.
Answer: TRUE
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
19) Because international capital budgeting is so difficult, time consuming, expensive, and
uncertain, firms generally forego any type of additional sensitivity analysis after completing a
base-case scenario.
Answer: FALSE
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Conceptual
AACSB: Application of knowledge
20) A criticism of adjusting the discount rate to account for political risk is that adjusting the
discount rate for political risk penalizes early cash flows too heavily while not penalizing distant
cash flows enough.
Answer: TRUE
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Recognition
AACSB: Application of knowledge
21) When dealing with international capital budgeting projects, the value of the project is NOT
sensitive to the firm's cost of capital.
Answer: FALSE
Diff: 2
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Conceptual
AACSB: Application of knowledge
22) Explain how political risk and exchange rate risk increase the uncertainty of international
projects for the purpose of capital budgeting.
Answer: The evaluation of foreign projects must consider several risks that are either
nonexistent or much less important in domestic capital budgeting. First, if revenues and expenses
are in a foreign currency, then the parent firm must estimate the exchange rate at which the
foreign currency will be converted into the domestic currency. To estimate future exchange rates,
the parent firm must estimate expected rates of inflation and interest rates in both countries,
economic growth in each country, as well as consumer preferences and tastes in more than one
country. Then, aspects of political risk must be considered. What is the likelihood that all or part
of the cash flows accruing to the parent firm will be restricted through some political act? The
firm must now consider the possibility of changing tax rates, new taxes, and additional
restrictions on the flow of funds. Furthermore, local norms may differ from usual firm practice in
terms of financing or dividend policy. Domestic capital budgeting may seem quite easy in
comparison.
Diff: 3
L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia
Skill: Conceptual
AACSB: Application of knowledge
18.3 Real Option Analysis
1) Real option analysis allows managers to analyze all of the following EXCEPT:
A) the option to defer.
B) the option to abandon.
C) the option to alter capacity.
D) All of the above may be analyzed using real option analysis.
Answer: D
Diff: 2
L.O.: 18.3 Real Option Analysis
Skill: Recognition
AACSB: Application of knowledge
2) Real option analysis treats cash flows in terms of future value in a positive sense, whereas
DCF treats future cash flows negatively.
Answer: TRUE
Diff: 1
L.O.: 18.3 Real Option Analysis
Skill: Conceptual
AACSB: Application of knowledge
3) Real option analysis is a particularly powerful device when addressing potential investment
projects with extremely long life spans or investments that do not commence until future dates.
Answer: TRUE
Diff: 1
L.O.: 18.3 Real Option Analysis
Skill: Conceptual
AACSB: Application of knowledge
4) What is real option analysis? How is it a better method of making investment decisions than
using traditional capital budgeting analysis?
Answer: Real options is a different way of thinking about investment values. At its core, it is a
cross between decision-tree analysis and pure option-based valuation. It is particularly useful
when analyzing investment projects that will follow very different value paths at decision points
in time where management decisions are made regarding project pursuit. This wide range of
potential outcomes is at the heart of real option theory. Real option valuation also allows us to
analyze a number of managerial decisions that in practice characterize many major capital
investment projects:
1. The option to defer
2. The option to abandon
3. The option to alter capacity
4. The option to start up or shut down (switching)
Real option analysis treats cash flows in terms of future value in a positive sense, whereas DCF
treats future cash flows negatively (on a discounted basis). Real option analysis is a particularly
powerful device when addressing potential investment projects with extremely long life spans or
investments that do not commence until future dates.
Real option analysis acknowledges the way information is gathered over time to support
decision-making. Management learns from both active (searching it out) and passive (observing
market conditions) knowledge-gathering and then uses this knowledge to make better decisions.
Diff: 2
L.O.: 18.3 Real Option Analysis
Skill: Conceptual
AACSB: Application of knowledge
18.4 Project Financing
1) Which of the following is NOT a factor critical to the success of project financing?
A) separability of the project from its investors
B) long-lived and capital intensive singular projects
C) cash flow predictability from third part commitments
D) All of the above are critical factors for project financing.
Answer: D
Diff: 2
L.O.: 18.4 Project Financing
Skill: Conceptual
AACSB: Application of knowledge
2) Which of the following is NOT a characteristic of international long-term capital project
financing?
A) The projects are large in scale.
B) The projects are long in life.
C) The projects are generally high in risk.
D) The projects may be all of the above.
Answer: D
Diff: 2
L.O.: 18.4 Project Financing
Skill: Recognition
AACSB: Application of knowledge
3) The predictability of the project's revenue stream is essential in securing project financing.
Which of the following is NOT a typical contract provisions that are intended to assure adequate
cash flow?
A) quantity and quality of the project's output
B) a pricing formula
C) circumstances that permit changes in the contract
D) fronting loan
Answer: D
Diff: 2
L.O.: 18.4 Project Financing
Skill: Recognition
AACSB: Application of knowledge
4) Project financing is the arrangement of financing for very large individual long-term capital
projects.
Answer: TRUE
Diff: 1
L.O.: 18.4 Project Financing
Skill: Recognition
AACSB: Application of knowledge
5) Debt is usually a large component of project financing.
Answer: TRUE
Diff: 1
L.O.: 18.4 Project Financing
Skill: Recognition
AACSB: Application of knowledge
6) The level of debt places an enormous burden on cash flow for debt service and requires a
number of additional levels of risk reduction.
Answer: TRUE
Diff: 1
L.O.: 18.4 Project Financing
Skill: Recognition
AACSB: Application of knowledge
7) In project finance, retained earnings and the reinvestment of earnings are the most important
decisions to guarantee the long-term growth of the project's value.
Answer: FALSE
Diff: 1
L.O.: 18.4 Project Financing
Skill: Recognition
AACSB: Application of knowledge
18.5 Cross-Border Mergers and Acquisitions
1) Which of the following is NOT a reason given for international mergers and acquisitions?
A) gaining access to strategic proprietary assets
B) gaining market power and dominance
C) diversifying and spreading their risks wider
D) All of the above are commonly cited reasons for international mergers and acquisitions.
Answer: D
Diff: 2
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge
2) Which of the following changes does NOT create business opportunities for select firms to
both enhance and defend their competitive positions in global markets?
A) changes in technology
B) changes in regulation
C) changes in capital markets
D) changes in management
Answer: D
Diff: 2
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge
3) The process of acquiring an enterprise anywhere in the world has three common elements
EXCEPT:
A) identification and valuation of the target.
B) execution of the acquisition offer and purchase—the tender.
C) management of the post-acquisition transition.
D) All of the above are common elements in acquiring an enterprise anywhere in the world.
Answer: D
Diff: 2
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge
4) Which of the following is NOT an advantage of cross-border acquisitions over greenfield
investments?
A) quicker
B) cost-effective
C) target firms to be undervalued
D) melding corporate cultures
Answer: D
Diff: 2
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge
5) Which of the following is NOT a typical pitfall of cross-border acquisitions?
A) paying too much
B) excessive financing costs
C) melding corporate cultures
D) all of the above are pitfalls
Answer: D
Diff: 2
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge
6) Currency risk is a concern for any international merger and acquisition activity. For instance,
the initial bid, if denominated in a foreign currency, creates a contingent foreign currency
exposure for the bidder.
Answer: TRUE
Diff: 1
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Conceptual
AACSB: Application of knowledge
7) Currency risk is a concern for any international merger and acquisition activity. For instance,
once the bidder has successfully won the acquisition, the exposure evolves from a transaction
exposure to a contingent exposure.
Answer: FALSE
Diff: 1
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge
8) The drivers of international merger and acquisitions are only MACRO in scope.
Answer: FALSE
Diff: 1
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge
9) As opposed to greenfield investment, a cross-border acquisition is typically quicker.
Answer: TRUE
Diff: 1
L.O.: 18.5 Cross-Border Mergers and Acquisitions
Skill: Recognition
AACSB: Application of knowledge